Combat high rates with debt consolidation

Your trips to the grocery store and gas pump over the past few years have sent a clear signal: Prices continue to rise at an incredibly fast clip. Why? Partially because the Federal Reserve has been raising the federal funds rate to combat the possibility of hyperinflation. Fortunately, this fed rate has actually been coming down since August 2024, but it remains high when compared to interest rates in 2022.

The experts rate debt consolidation as a great option if you want to pay down credit card debt, personal loan debt, and other outstanding balances on high-interest financing accounts you may have. That’s because the interest rates charged for a home equity loan, home equity line of credit (HELOC), and cash-out refinance are likely much lower than what you are currently paying.  

Take the time to better understand what impacts interest rates, including mortgage rates, before you choose a home equity loan, HELOC, or refinance home loan and consolidate debt. Read on to learn more.

What is the federal funds rate?

It’s easy to think of interest rates as only impacting consumers. However, financial institutions often borrow from each other to fund their day-to-day operations. This borrowing is regulated by the Federal Reserve through the federal funds rate, also called the fed funds rate.

The fed funds rate is the amount of interest that banks charge when they borrow from each other overnight. When this rate goes up, it becomes more expensive for banks to borrow money from each other. The current range for the federal funds rate is 4.25% to 4.50%, with an average rate of 4.33%. This cost is passed through to consumers starting with the bank’s prime rate.

“Raising the federal funds rate has been the Federal Reserve’s attempt to stabilize prices, combat inflation, and avoid a recession,” says Leslie Tayne, a finance and debt expert and founder of Tayne Law Group. “Although prices have come down since 2022, inflation has not yet settled at the 2% benchmark the Fed is hoping for, which is why the federal funds rate higher than usual.”

What is the prime rate?

A bank’s prime rate is the rate it gives its best customers. Who are these lucky recipients, you wonder? They’re often well-established corporate clients who they judge to be least likely to default on their loan obligations. Often, consumers aren’t able to qualify for the prime rate on a loan application if their credit is below exceptional.

When banks set the prime rate they want to charge, it’s typically calculated by adding a margin to the federal funds rate. If, for example, Main Street Bank adds a 3% margin to the federal funds rate (which, at the time of this writing, is averaging 4.33%), the current prime rate would be 7.33%.

“The prime rate often becomes the starting point for many credit products, including credit cards and HELOCs,” Ryan Zomorodi, real estate professional and co-founder of Real Estate Skills, says.

How the federal funds rate impacts consumer interest rates

Although you may not qualify for the prime rate, other rates offered by lenders are usually built on the prime rate plus a margin. Because the prime rate is itself derived from the federal funds rate, the latter is the benchmark for many consumer interest rates. Changes to the fed rate and prime rate will trickle down to an array of consumer products. Let’s explore a few of these.

Credit cards and personal loans

When the Fed raises rates, one of the first things consumers notice is the impact on their credit card rates. Credit cards have short-term balances that can change from month to month. As a result, these are the most sensitive to changes in the federal funds rate. In fact, if you look closely at your credit card contract, it probably indicates that your credit card rate is the prime rate based on some source added to a margin.

“Credit card interest rates are usually set at the prime rate, plus – depending on your creditworthiness – some extra amount called a ‘margin.’ This is known as the annual percentage rate (APR). For example, if the prime rate is 8%, and your margin is 15 percentage points, your credit card issuer can charge up to 23%,” says Dennis Shirshikov, a professor of finance and economics at City University of New York/Queens College.

Consolidating high-interest credit card debt with a home equity product can be smart in many situations. As mentioned earlier, good options include pursuing a cash-out refinance, HELOC, or home equity loan and using those funds to pay off your high-interest debt.

Tayne says the best candidates for these vehicles are those who can make consistent loan repayments, are managing large sums of high-interest debt, and have enough equity built up in their home to liquidate.

“The advantage here is being able to consolidate your debt into a lower interest rate sum, thereby reducing the total sum you will pay over time,” she says. “But consolidating debt with a HELOC or other home equity product may not make sense if you don’t have much equity accrued in your home to begin with, or if you have subprime credit – as it’s unlikely you will be approved for the loan.”

Also, keep in mind that you’ll need to use your home as collateral if you go the cash-out refi, HELOC, or home equity loan route. That can be risky if you don’t have a thorough and realistic repayment strategy in place and aren’t committed to using your credit cards responsibly.

“Without that strategy, you can dig yourself into a deeper debt cycle and end up worse off than before,” Tayne says. “I’ve seen clients get a home equity loan and then end up taking on more debt because the underlying issue of why they had high-interest debt in the first place was never addressed.”

When it comes to personal loans, if you have a fixed rate, what you pay won’t fluctuate like credit cards. However, rates for new personal loans could go up quickly if and when the fed rate rises.

Mortgages

Mortgage rates work a little differently because they are based on the yields of mortgage-backed securities sold to investors in the bond market. The federal funds rate and mortgage rates tend to follow in the same general direction. That’s because if interest rates in general are rising, investors want to see a higher rate of return on their investment. Mortgage rates on new loans tend to go higher when the fed funds rate increases. But it’s not an immediate one-to-one correlation. If you currently have a fixed-rate mortgage loan, federal funds rate changes won’t affect your current mortgage payment.

“Mortgage rates are influenced more by the bond market than the fed funds rate. When bond prices increase, mortgage rates typically decrease, and vice versa,” Tayne says.

Consider, as well, that mortgage rates usually track the 10-year Treasury note.

“When investors expect rates to stay high, bond yields go up – and mortgage rates follow,” says Zomorodi.

It’s also important to note that, even when rates are going up, mortgages tend to be at the lower end of the spectrum. The reasoning here is that if you are going to make any payment, you’ll probably make your house payment first. Therefore, mortgage-backed securities are considered among the least risky investment vehicles for investors.

Opting for a mortgage refinance to help consolidate your debts could be the ideal solution.

“Let’s say you have $20,000 in credit card debt at an APR of 24%. That equates to about $400 per month in interest charged alone,” says Zomorodi. “But if you roll that debt into a refinance at a fixed 6.75% interest rate, your mortgage payment will increase by about $130 to $150 per month, but you will cut your overall interest dramatically and simplify payments.”

On the other hand, if you already have a low mortgage rate that you don’t want to reset, or you are close to paying off your mortgage loan, refinancing for the primary purpose of paying off a short-term debt could cost you more in the long run.

“You could end up paying a lot of interest over your new refinance loan term of 15 to 30 years just to eliminate short-term debt, which doesn’t make sense in this scenario,” Zomorodi says.

Using your home equity to consolidate debt

As we mentioned earlier, the interest rate on credit cards is whatever the prime rate is plus a margin added by the bank. However, it’s important to note that the margin added by your credit card company could be 20% or higher, depending on your qualifications. While it’s true that credit card rates are always high compared to others, the situation really comes into focus when rates are on the rise.

Fact is, interest charged on a mortgage loan is typically much lower than interest charged by a credit card or personal loan. Case in point: Even if you get a mortgage with a fixed rate of 6%, that’s still preferable to paying 22% interest on a credit card carrying a balance. Let’s run through a quick example.

Assume you’re paying 22% interest on $20,000 worth of credit card debt. If you make the minimum payment (in this example, the existing interest +1% of the loan balance), you’ll end up paying $36,026.45 in interest over time. The minimum monthly payment is $566.67.

But let’s say you can get an interest rate of 6% on a 30-year refinance home loan and consolidate debt with those extra funds. The interest you pay on the $20,000 being added to your balance is only $23,167.64. Imagine you start with a balance of $120,000 on a 30-year loan. Taking cash out and increasing your balance to $140,000 only adds about $120 per month to your payment and saves you nearly $13,000 in interest compared to slowly paying down your credit card balance.

Let’s tweak this example even further to imagine higher rates. If your cash-out rate today is 6.75%, and your credit card APR is 24%, here’s what your payments would look like:

Consider, too, that paying off your credit card balance lowers your debt-to-income ratio (DTI). This is a key determinant of the kind of monthly payment you can afford when trying to qualify for any kind of financing. Eliminating credit card debt allows you to put yourself in a better financial position moving forward.

That’s because credit cards are often rated as “bad debt” compared to mortgage loans, which are rated as “good debt.”

“Credit card debt can get a bad reputation because it carries a higher interest rate and it’s easy to go overboard on spending – creating balances that get reported to the credit bureaus, which lowers your credit score. Also, credit card debt is an unsecured form of debt, meaning there is no collateral backing up the credit. This increases risk for the lender and results in higher rates and greater difficulty in paying off the debt,” says Tayne. “Consumers easily get sucked into taking on more credit cards, which, again, negatively impacts your credit in several ways, causing it to fall into the bad debt category.”

But mortgages are viewed as good debt because you carry a larger balance and have a secured loan type backed by collateral, which will be used to purchase an asset (your home) that will benefit you in the long run.

Every situation is different, but in general, homeowners are in a great position to tap their equity. According to data from the first quarter of 2025 supplied by Cotality, home equity rose 0.7% year-over-year to settle at $17.3 trillion.

The bottom line: Debt consolidation can be smart when rates are low

Interest rates may be declining, but not every rate is impacted equally. Consumers are likely to feel the greatest impact of the movements by the Federal Reserve to increase the federal funds rate on their credit card statements.

In addition to having high rates in general, credit card interest rates are directly correlated with the federal funds rate. Using your home equity to consolidate high-interest credit card debt can allow you to save on interest and lower your DTI, improving your overall financial picture for the future. To help you make a more informed decision on this matter, use a home equity calculator.

If you’re thinking cash-out debt consolidation makes sense for you, you can contact a Home Loan Expert or apply online.