Team Approach To Refinancing Part III: Reducing Debt

The term consumer debt would apply to all the debt a homeowner owes, besides loans that are secured by the real estate they own.  In other words, their mortgage loan would not be considered consumer debt, but their car loan would. Generally, consumer debt is more important to pay off before mortgage debt because consumer debt tends to carry a higher interest rate and is generally not tax deductible.   Again, here is another reason to have financial advisors involved in the transaction as your accountant should be consulted when determining what debt is deductible and what is not.

If someone is carrying high levels of consumer debt, it may not make sense to use a lower interest rate to shorten the term of the mortgage.  There are two ways that a refinance could help pare down this consumer debt:

1. If there is enough equity in the home, the consumer may be able to consolidate debts using cash taken out when refinancing.  The overall payment savings could then be applied to lowering the term of the mortgage in the long-run.
2. If there is not enough equity to take cash out to consolidate debts, the homeowner could use the payment savings to apply towards a more rapid pay-down of consumer debts. Then, after the consumer debts are paid off, the homeowner can then concentrate on paying off the mortgage more quickly if that objective is desirable. This is a “debt-roll-down” approach.

These are decisions that will affect the long-term financial plan of the homeowner and this example demonstrates why refinancing should take place with the advice of the homeowner’s financial team of a mortgage lender, financial advisor and accountant.