Debt Consolidation Using Mortgage Refinancing

If you’re feeling overwhelmed by debt, you’re not alone. Many Americans are saddled with large 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 are paying double or even triple the interest rates on credit cards than on most car 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 a mortgage refinance to pay off your debts.

Can you refinance to pay off debt?

A cash refinance can help you consolidate your debt by capitalizing on low mortgage interest rates while tapping into the equity in your home. Since mortgage rates are generally lower than other loans such as student loans, personal loans, or credit cards, it may be beneficial for you to consolidate your debt by refinancing your home.

For example, if you took $16,000 of your home equity to immediately pay off your credit debt, then the $16,000 would be added to your mortgage. The average interest rate on a 15-year fixed mortgage is 3.5%, which is significantly lower than the average credit card rate.

With this interest rate, you would pay $4,600 in interest instead of nearly $15,000. A refinance would save you over $10,000 on that $16,000 debt.

Mortgage refinance options

When considering a mortgage refinance, it is important to know what type of options are available. While only a cash-out refinance will allow you to consolidate your debt, other forms of refinance can help you save money to pay off your debt.

Refinancing by withdrawal

A cash refinance will allow you to consolidate your debt. This process involves borrowing money against your home equity and using it to pay off other debts, such as credit cards, student loans, car loans, and medical bills.

Essentially, you pay off all existing balances by transferring them to your mortgage. This puts all 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.

Refinancing rate and term

With a rate and term refinance, your original loan balance is paid off and a new loan is opened to secure you a new interest rate or 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.

Streamline refinancing

Qualifying government-insured mortgages may be eligible for an FHA streamlined refinance or a VA streamlined refinance. With this option, a new assessment is not necessary. 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. To determine if a cash-out refinance is right for you, ask yourself the following questions.

Will I be eligible for a mortgage refinance?

To be eligible for a mortgage refinance, you will need to meet the following criteria:

Do I have enough equity?

Since you will be using the equity in your home for a cash refinance, you will need to have enough money to borrow while keeping a remaining portion in the home. This is a requirement of most mortgage investors.

The amount of equity you leave in your home after refinancing matters because it affects your loan-to-value (LTV) ratio. 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 over 80%, your lender may require you to pay for this insurance.

Recent changes mean that you also have trouble withdrawing money if you have an LTV above 80%. You will only be able to do this if you qualify for a VA loan.

To see how a cash-out refinance might affect your LTV, follow the formulas below to calculate your numbers and compare.

Loan Balance / Appraised 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 home 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) / Appraised Property Value = LTV

To determine your LTV amount with a cash refinance, simply add the amount of equity you wish 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 rollover would be 78%.

Property value = $200,000

Loan balance = $140,000

Cash out amount borrowed = $16,000

New loan balance – $156,000

156,000 / 200,000 = 0.78

With an LTV of 78%, you can refinance in cash with enough equity remaining to avoid PMI.

Use this formula to calculate what your LTV would be after a refinance. If it’s over 80%, you might want to seriously consider whether removing that capital would give you enough money to meet your goals.

Can I afford a higher monthly mortgage payment?

Refinancing does not get rid of debt. It transfers it to another debt – your mortgage. When you refinance, your mortgage balance will increase by the amount of equity you borrowed. So, for example, if you borrowed $16,000 of your principal 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 payment. And depending on the terms of your refinance, 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, a refinance may not help. It could even put you at risk of foreclosing on your home.

Does the cost of the mortgage make sense compared to other options?

Just like you would with an original mortgage, you will have to pay closing costs for a mortgage refinance. Underwriting and origination fees are common closing costs associated with a refinance. Some additional costs may include application fees, appraisal fees and attorney review fees. The total closing costs of a refinance will depend on the amount you borrow, where you live and the lender you choose.

If the cost of a mortgage refinance 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 you 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.

Although 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 benefit from the potential tax benefits of a mortgage refinance, which includes the ability to deduct mortgage interest.

The Bottom Line: Know Your Individual Needs and Financial Goals Before You Refinance to Pay Off Debt

If you think a mortgage refinance might be the debt consolidation solution you’re looking for, you can get full refinance approval online through Rocket Mortgage®.

If you’d rather speak with one of our friendly and knowledgeable home loan experts, we’d be happy to take your call at (800) 785-4788. For 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 managed to consolidate your debts? Share in the comments below.