Should You Refinance Your Mortgage to Pay Off Debt?
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According to this, the average American household has $92,727 in personal debt experiential Data – and if you’re in a similar situation, you might be looking for a way to consolidate your balances and save on interest.
One option you can take as a homeowner is a payout refinance, but there are pros and cons to consider before taking this approach.
Here’s how to determine if using a cash-out refinance to pay off high-interest debt is right for you:
How refinancing your mortgage can help you pay off debt
When you refinance a mortgage to pay off debt, one of the main benefits is that you pay less in interest costs. Mortgage interest rates are much lower than interest rates on other consumer products such as credit cards, personal loans, and personal student loans.
How you use a refinance to pay off your debt depends on whether you’re doing interest and term refinancing or payout refinancing.
Interest rate and term refinancing
Best for: Homeowners who qualify for a lower interest rate and have low debt balances
An interest rate and term refinance allows you to take out a mortgage with a new loan term, a new interest rate, or both. The old loan will be paid off and you will make payments on the new mortgage over time.
Ideally, you save money with a lower interest rate — and use those savings to pay off your higher-interest debt.
Refinancing into a new 30-year loan with a 3% interest rate can bring your monthly payment down to $1,240 per month. With the monthly savings of $450, you could pay off a $5,000 credit card balance in a year assuming an 18% APR on the card.
Cash-out refinancing
Best for: Homeowners paying a high interest rate on a large amount of debt
When you do a payoff refinance, you take out a new mortgage loan for more than what you owe, pay off the original mortgage, and pocket the difference in cash. You can then use this money to pay off other debts.
To qualify for a cash-out refinance, you must have sufficient home equity and meet credit requirements.
If the lender gives you the extra $10,000 in cash, use that to pay off the credit card balance.
See: Reasons to Cash Out Refinance: How to Leverage Your Home Equity
How to qualify for a cash out refinance
The qualifying requirements for a cash-out refinance are different than other refinances because you’re borrowing from your home equity loan.
- A credit score of 620 or higher
- A debt-to-income ratio of no more than 45%
- Enough equity in your home to keep 20% equity after refinancing
If you decide that cashout refinancing is right for you, compare as many options as you can to find a great deal. Credible makes this easy – you can compare multiple lenders and view personalized pre-qualified rates in just minutes.
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find out: What documents do you need to refinance your mortgage? A checklist
Pros and cons of refinancing to pay off debt
The most immediate benefit you get from refinancing is that you save money. However, this step can also affect your credit score and you need to consider the costs involved. Consider these pros and cons before refinancing your home to pay down debt.
benefits
- You could save money every month. When you use interest rate and term refinancing to consolidate debt, you get a loan with a lower interest rate. The benefits are twofold: not only do you save on interest, you also benefit from a lower mortgage payment.
- You could pay off the debt faster. Your other option is to use a cash-out refinance, which increases your mortgage payments – but this allows you to pay off high-yield balances quickly.
- You could get a tax benefit. The interest you pay on a mortgage is tax deductible if you qualify and list your deductions. The balances you pay back with a refinance – such as B. Credit card debt – are generally not tax-advantaged.
disadvantage
- You use your home as collateral. When you use a cash-out refinance to consolidate credit card debt, you are essentially converting unsecured debt into secured debt. Your mortgage payments will increase, and if you can’t keep up, the bank could foreclose on your property.
- Closing costs could eat up your savings. Calculate whether the cost of refinancing is worth it. Closing costs, which are fees you pay the lender to process the loan, average around $5,000. You can usually pay these costs up front or include them in the new mortgage.
- The loan could affect your credit score. When you apply for refinance, the lender conducts a rigorous review of your credit reports. This could temporarily lower your credit score. Refinancing also resets the average age of your credit history, which could also affect your credit score.
Learn more: How to get the best mortgage refinance rates
Should You Refinance to Pay Off Debt?
Home loan refinance Consolidating debt might make sense if you qualify for new loan terms that will help you save money.
Here are some questions to ask yourself before applying:
- What type of refinance is best for me?
- Am I eligible for refinancing?
- Can I afford the new mortgage payment if I do a payout refinance?
- How much money will I save each month if I do interest rate and term refinancing?
- If I change the term of the mortgage loan, will I pay more interest overall? Am I OK?
Learn more:
Other ways to pay off debt
There are other ways to pay off debt without using your home as collateral. Start by figuring out how much you’re making, how much of your income goes towards essential expenses, and how much is left over to pay off your debt each month.
Then, check out the following strategies for paying off debt. The best method depends on your financial situation or preferences.
Get a credit card for the balance transfer
Best for: People who can pay off their debts in a relatively short amount of time
A balance transfer allows you to transfer multiple debt balances onto one credit card. Some have an introductory APR of 0% for a longer period of time, typically 12 to 21 months. If you can pay the balance within this period, you can save money.
The interest rate usually goes up after this introductory period, so if you have any remaining balance, your debt could become expensive.
Also, this option might not help much if you can’t consolidate all your debt. You may get different credit terms – and issuers may limit the amount you can transfer to the account.
Get a debt consolidation loan
Best for: People who want to pay off debt over a longer period of time
A debt consolidation loan is typically an unsecured personal loan that you pay back in installments over time, typically three to five years. This can be a good option if you qualify for one with good terms and prefer a predictable payment schedule.
Use the debt snowball method
Best for: People with relatively small, low-interest debt
It may not be worth consolidating your debt if you have small balances that you can pay off within a year or if you don’t qualify for a personal loan or credit card.
With the debt snowball method, you make the minimum payments on all of your debts each month, but you invest any extra money in your smallest debts first. Then move in order from the next smallest to the largest balance. You should gain momentum like a snowball rolling down a hill.
Use the debt avalanche method
Best for: people with high-interest debt
The debt avalanche method is also a good option for people who don’t qualify for a loan or credit card and will help you save on interest.
You make the minimum payments on all your debts, but put your extra income on the balance with the highest interest rate. Once it’s paid off, move on to the balance with the next higher interest rate until all of your debt is gone.
Consider a debt relief program
Best for: People who cannot afford their minimum monthly payments
You may need professional financial help if you can’t pay your monthly debts, can’t pay off your unsecured debts within a few years, or your debts are more than half of your income.
Contact a nonprofit credit counseling center. A certified financial advisor can go through your finances with you and help you create a plan of attack.
If you’re still looking to refinance, Credible can help you find the latest interest rates for your next mortgage refinance. With Credible you can compare multiple personalized rates from our partner lenders in just minutes – it’s free, secure and won’t affect your credit score.
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