The end of the year can be a crazy busy time, and the last thing…
If you are carrying a lot of high-interest debt, it can be overwhelming and cause a massive blow to your monthly budget. But the good news is that, if you have equity in your home, a debt consolidation refinance may be a great solution. It could allow you to pay off those pesky credit cards, car loans, or other debts and save you a ton of interest.
Your house is likely your largest asset, and you can borrow against your home’s equity to get cash when needed, especially to pay off high-interest debt. Some options for doing this are through a home equity line of credit (HELOC), a home equity loan, or a cash-out refinance.
While every situation is unique, for many homeowners, a cash-out refinance is the first consideration for debt consolidation.
Before we dive into the pros and cons, let’s discuss what debt consolidation is and how using a cash-out refinance can help you achieve your debt pay-down goals.
What Is Debt Consolidation?
Consolidating debt means taking out a new loan and using that money to pay off other debts, like high-interest credit cards, other loans, or medical bills. When you consolidate your debt, you make one payment to one lender instead of multiple payments to multiple lenders or creditors each month.
Debt consolidation not only makes your bills easier to manage, but assuming that the interest rate is lower on your new loan, you can also significantly reduce the amount you would have paid over time toward your other higher-interest debts.
Home loan interest rates are typically much lower than credit card rates, which is why using a cash-out mortgage refinance to pay off credit card debt could be a smart move. But there are costs involved with refinancing—and of course a new monthly mortgage payment you’ll need to make.
What Is a Cash-Out Refinance?
A cash-out refinance is when you replace your current mortgage with a new mortgage for a higher loan amount. The difference between your existing and new mortgage is paid to you in cash at closing. The new mortgage’s interest rate and term will likely change, and the amount owed increases as additional debt is rolled into the balance of your new mortgage.
So where’s the benefit? Let’s say mortgage rates on a cash-out refinance are at 6.75% today and you have borrowed money or have maxed out credit cards that are at 17.5%. Depending upon the amount owed, you could be saving money in payments and interest by paying off those high-interest credit cards with the cash out from your home.
What Are the Requirements for a Cash-Out Refinance?
To be eligible for a cash-out refinance, you must have equity in your home. Equity is calculated by taking your home’s current market value and subtracting how much you still owe on your mortgage. For instance, if your house is worth $400,000 and you owe $200,000 on your mortgage, then you would have $200,000 in equity in your home.
To qualify for a cash-out refinance, you’ll need to provide financial documents and pay closing costs, just like you did when obtaining your prior mortgage.
How Does a Cash-Out Refinance Work?
With a cash-out refinance, you take out your home equity in cash, and in exchange, your lender assigns a higher principal balance on your new mortgage, which replaces your old mortgage. Then you make monthly mortgage payments to your lender, just like you did with your previous loan.
Let’s say you have a $200,000 principal balance on your current mortgage and $30,000 in other debts you want to pay off. You apply for a cash-out refinance and get a new mortgage for $230,000. The lender then gives you the difference ($30,000) or pays off the debts directly when your loan closes.
Pros and Cons of Debt Consolidation Refinance
Debt consolidation refinance pros
The biggest benefit of a debt consolidation refinance is that you’ll save a significant amount of money in the long run by simply lowering the interest rate on your outstanding debts. Consolidating debt can also increase your credit score, as it reduces your credit utilization ratio.
Additionally, the interest you pay on your mortgage can be tax deductible, while credit card interest is not tax deductible.
Debt consolidation refinance cons
A risk when refinancing for debt consolidation is that you could run up high-interest debt again. It’s not uncommon for those who refinance to pay off their debts to put themselves in the same situation again.
Another con is that your loan term will likely be longer when you refinance. If you were 10 years into a 30-year mortgage, when you refinance, your remaining term could increase from 20 to 30 years, meaning 10 more years of paying interest. So even though you’ll enjoy the savings from consolidating your higher-interest debt, you could be paying more over the long term.
A debt consolidation refinance, specifically a cash-out refinance, may be the right way to pay down your high-interest credit cards or other debts and lower your monthly payments. Just be sure you can afford your monthly mortgage payments, and practice discipline by not racking up new unmanageable debt down the road.
If you’re looking to consolidate debt with a cash-out refinance, the team at New Way Mortgage can help. We have access to competitive interest rates and various programs, including cash-out refinances for conventional, VA, and FHA loans.
Call us at 916-465-6639, and let us match you with the mortgage that makes the most sense for your refinancing situation.