Refinance House Vs. Pay Off Debt
If you're considering how to best utilize your extra cash and are considering either refinancing your mortgage or paying off debt, you may be luckier than you realize. Both approaches offer significant advantages and disadvantages, but think carefully before you commit to any one plan. A better option that you haven't considered may be waiting.
Other People Are Reading
-
Refinancing Your Home: Pros
-
Refinancing your mortgage to lower your payments seems like a slam dunk: less interest paid over time that can total hundreds of thousands of dollars, freed-up monthly cash flow, and a potentially shorter term. There's also the satisfaction of knowing that you will own your home free-and-clear for less money and in less time.
If you're near retirement and have maxed out your contributions to an employer-sponsored plan, refinancing to a lower rate should provide you with greater financial stability after your paychecks cease. Alternatively, if putting more money into your home will significantly decrease your rate, this is a good choice.
Refinancing Your Home: Cons
-
Think carefully before you commit extra funds to your home. Although the interest savings seem impressive, you may generate a better return on your money by using the funds elsewhere. Since mortgage interest is usually tax-deductible, your true interest rate may be less -- much less -- than you think, and lowering your interest rate lowers your mortgage interest deduction, as well.
If you owe more on your home than it's worth, putting money into a refinance should not be considered. If you default on your mortgage, that money is lost if the home forecloses or is sold in a short sale. Consider also that mortgage interest rates are usually cheap, and that the first rule of paying down debt is to pay off high interest rate balances first.
-
Paying Off Debt: Pros
-
Although paying off debt may not seem like an investment, consider that you're earning a return on every dollar you pay off. For example, if you have a 16 percent interest rate on a credit card, you're earning 16 percent on every dollar of debt you pay off, a significantly higher return than your mortgage interest payment. There is also the satisfaction of knowing your credit cards are paid in full.
In addition, you will likely improve your credit score and be more appealing to lenders should you apply for a loan in the future. You will free up your monthly cash flow significantly, which helps in the event of an emergency. Remember to pay your highest interest debt first to maximize your return.
Paying Off Debt: Cons
-
Credit card balances are unsecured debt, so if you default on the payment, your house or other possessions won't be confiscated. Your credit will suffer tremendously, but if you're already delinquent, it's suffered anyway.
There are nonprofit organizations to assist you with managing your debts. Call the National Foundation for Credit Counseling. You'll get a free one-hour consultation from a counselor certified in budget and debt management. You may elect to participate in a debt management program with lowered interest rates. There are risks; contact the NFCC for details. Also, consider that you may reap a greater return putting your money to use elsewhere, such as in an employer-sponsored retirement plan.
Alternatives
-
If you are able to manage your monthly expenses without difficulty and have extra funds to put to good use, contributing more to an employer-sponsored retirement plan such as a 401k may provide the greatest return of all, especially if your employer matches your funds. IRAs offer similar benefits.
Remember that your retirement income is largely up to you, and contributions to these plans offer significant tax benefits now and in the future. Finally, professional investment advisers offer analytical services that will give you a clear picture specific to your resources and needs. If you have money to put to work, the world is your oyster.
-
References
- MSN MoneyCentral; Don't Rush to Pay Off That Mortgage; Liz Pulliam Weston, Sep. 30, 2010
- MSN MoneyCentral: The 5 Worst Pieces of Financial Advice; Liz Pulliam Weston, Mar. 26, 2011
- Bloomberg Business Week; Refinancing Your Mortgage; Lauren Young
- MSN MoneyCentral; 3 Ways to Be Smarter About Money; Liz Pulliam Weston, Mar. 25, 2011
Resources
- Photo Credit Stockbyte/Stockbyte/Getty Images
