If you are feeling overwhelmed with debt, you are not alone. Many Americans face significant credit card debt in addition to mortgages, student loans, car loans, and medical bills.
With some of the highest interest rates of all debt, credit card debt is one of the worst to bear. In fact, consumers pay double or even triple the interest rates on credit cards than on most auto loans, student loans, and home loans.
For homeowners, the good news is that there may be a way to help you manage your finances better by using mortgage refinancing to pay off your debt.
Can You Refinance To Pay Off Your Debt?
Refinancing with cash can help you consolidate your debt by taking advantage of low mortgage interest rates while digging into your home equity. Since mortgage rates are generally lower than those of other loans such as student loans, personal loans, or credit cards, you may find it beneficial to consolidate your debt by refinancing your home.
For example, if you took $ 16,000 from your home equity to immediately pay off your credit debt, then the $ 16,000 would be added to your mortgage. The average interest rate for a 15-year fixed rate mortgage is 3.5%, which is significantly lower than the average rate for credit cards.
With this interest rate, you would pay $ 4,600 in interest instead of almost $ 15,000. Refinancing would save you over $ 10,000 on that $ 16,000 debt.
Mortgage refinancing options
When considering mortgage refinancing, it is important to know the type of options available. While only cash refinancing will consolidate your debt, other forms of refinancing can help save you money to pay off your debt.
Refinancing of collection
Cash-out refinancing will allow you to consolidate your debt. This process involves borrowing money against the equity in your home and using it to pay off other debts, such as credit cards, student loans, car loans, and medical bills.
Essentially, you pay off existing balances by transferring them to your mortgage. This puts all the balances into one debt, so you only have to make one monthly payment. The biggest advantage is that you will only pay one much lower interest rate.
Rate and term refinancing
With interest rate and term refinancing, your original loan balance is paid off and a new loan is opened to secure you a new interest rate or a new loan term. You will then make all your future payments on this new loan.
By doing this, you can get a lower interest rate which will help you save money over time. With the extra money you save, you can pay off some of your higher interest debt.
Qualifying government insured mortgages may qualify for FHA Simplified Refinance or VA Simplified Refinance. With this option, a new assessment is not required. This can help reduce closing costs, making it an affordable consolidation option for those who qualify.
Should You Refinance Your Mortgage To Consolidate Your Debt?
As with any financial decision, you’ll want to do your research and consider all of your options. When deciding if a refinance with withdrawal is right for you, ask yourself the following questions.
Will I Qualify For Mortgage Refinance?
To be eligible for mortgage refinancing, you must meet the following criteria:
Do I have enough equity?
Since you will be using the equity in your home for cash refinancing, you will need to have enough money to borrow while still keeping some portion of the home. This is a requirement of most mortgage investors.
The amount of equity you leave in your home after refinancing is important because it affects your loan-to-value ratio (LTV). Your LTV determines if you need private mortgage insurance, or PMI, which can cost you hundreds of dollars on your mortgage payment each month. If your LTV is greater than 80%, your lender may ask you to pay for this insurance.
The recent changes mean that you are also struggling to withdraw money if you have an LTV above 80%. You will only be able to do this if you are eligible for a VA loan.
To see how a withdrawal refinance might affect your LTV, follow the formulas below to calculate your numbers and compare.
Loan Balance / Estimated Property Value = LTV
To calculate your LTV before refinancing, divide your loan balance by the appraised value of your property. The formula looks like this:
Let’s say your house is worth $ 200,000 and your loan balance is $ 140,000. Your LTV would be 70%.
Property value = $ 200,000
Loan balance = $ 140,000
140,000 / 200,000 = 0.70
(Borrowed Equity + Current Loan Balance) / Estimated Property Value = LTV
To determine your LTV amount with a withdrawal refinance, simply add the amount of equity you want to borrow to your current loan balance, then divide it by the appraised value of your property. The formula looks like this:
Using the example above, we’ll add the $ 16,000 you would borrow to pay off your credit card debt. Your new loan balance would be $ 156,000 and your new LTV after your withdrawal refinance would be 78%.
Property value = $ 200,000
Loan balance = $ 140,000
Amount of withdrawal borrowed = $ 16,000
New loan balance – $ 156,000
156,000 / 200,000 = 0.78
With an LTV of 78%, you can refinance cash with enough remaining equity to avoid PMI.
Use this formula to calculate what your LTV would be after refinancing. If it’s over 80%, you might want to seriously consider whether taking that equity would give you enough money to meet your goals.
Can I afford a higher monthly mortgage payment?
Refinancing does not eliminate debt. He transfers it to another debt – your mortgage. When you refinance, your mortgage balance will increase by the amount of equity you’ve borrowed. So, for example, if you borrowed $ 16,000 from your equity to pay off your credit debt, your mortgage balance will increase by $ 16,000.
No matter how much debt you transfer, increasing your mortgage balance will increase your monthly mortgage payments. And depending on the terms of your refinancing, the new loan could increase your monthly payment from a few dollars to a few hundred dollars.
Keep this in mind when considering your budget and financial goals. Will you be able to afford a higher mortgage payment? If you’re having trouble making your monthly payments now, refinancing may not help. It could even put you at risk of foreclosure.
Does the cost of the mortgage make sense compared to other options?
Just like you would with an initial mortgage, you will have to pay the closing costs of a mortgage refinance. Subscription and origination costs are ongoing closing costs associated with a refinance. Some additional costs may include application fees, assessment fees, and attorney review fees. The total closing costs of a refinance will depend on how much you borrow, where you live, and which lender you choose.
If the cost of mortgage refinancing is too high, another option to consider is to use a personal loan to consolidate debt. A personal loan may be better suited to your financial goals if:
- You want to keep your equity or don’t have enough equity to refinance.
- You want to take out a loan for a lower amount.
- You want to avoid higher closing costs.
While the closing costs can be significantly lower, the trade-off is that you’ll pay a higher interest rate than a refinance, but not as high as credit card interest rates. You also won’t get the potential tax benefits of mortgage refinancing, which includes the ability to deduct mortgage interest.
Conclusion: Know Your Individual Needs and Financial Goals Before Refinancing to Pay Off Debt
If you think mortgage refinance might be the debt consolidation solution you’re looking for, you can get full refinance approval online through Rocket Mortgage®.
If you prefer to speak to one of our friendly and knowledgeable mortgage experts, we would be happy to take your call at (800) 785-4788. With any major financial decision, you should speak with a financial advisor who understands your individual needs and financial goals.
Do you have any questions? Have you succeeded in consolidating your debts? Share in the comments below.