Should you refinance your mortgage to consolidate debt?
When you choose Debt Consolidation Refinance, it involves paying off high-interest debt for a loan with a lower interest rate. Consolidating debt allows you to save on interest payments in the long term. Costs can add up quickly if you owe a lot of high-interest debt, and it can become unbearable. For many, the apparent path is debt consolidation.
Currently, mortgage rates are at an all-time low, and a debt consolidation refinance could be a smart way to save money. Prior to making a decision on debt consolidation, it’s essential to realize all that is at play and learn these five benefits. It’s crucial to discern what’s involved with these strategies because securing high-interest debt against your home can be risky, so weigh all the pros and cons before determining.
How does debt consolidation work?
High-interest debt commonly originates from unsecured financing sources, like personal loans and credit cards. “Unsecured” means the lender contains no surety to regain losses if you run out on the debt. (Unlike a mortgage, which is “secured” by a tangible item; your home.) It’s easy to get in way over your head with many high-interest payments being sent to numerous lenders every month. Debt Consolidation Refinance is a straightforward way if you have predictable income and want to have affordable monthly payments.
The goal of a Debt Consolidation Refinance
The main goal of any debt consolidation strategy is to have more manageable monthly costs. For most homeowners, the lowest-cost source of money is their primary mortgage. Homeowners wanting to consolidate debt often use a cash-out refinance. Debt consolidation involves closing on a new home loan worth more than your current mortgage amount. The additional loan amount is cashed out at your closing.
Then, you use the cashed-out money to pay off your current high-interest debt, leaving you with one single debt to pay off: your mortgage. With this route, you’re conclusively paying off costly unsecured debts by means of a lower-interest mortgage loan. Funds received during a cash-out refinance can be used to pay off other significant obligations, like medical bills or student loans.
If your top goal is to become debt-free faster, then the highest-interest debts should take priority. The added benefit is that today’s mortgage interest rates are at near historic lows. So there’s a good chance you can lower your current mortgage rate and save on home loan interest as well as the interest on your other debts. Don’t forget that refinancing comes with closing costs, just like with your original mortgage.
Requirements of a Debt Consolidation Refinance
In order to consolidate debt using a mortgage refinance, you must qualify for the new loan. Requirements vary depending on your current loan type and the type of cash-out refinance you are applying for.
First, you will need enough equity to pay off the existing debts. You’ll typically need more than 20% equity to qualify for a debt consolidation mortgage. Most lenders want you to leave at least 20% of your home equity untouched when using a cash-out refinance. For instance, 30-40% equity is required to cash out 10-20% in cash.
You will additionally need to meet minimum credit score requirements. The most common type of refinancing is a conventional cash-out refinance, and it requires a credit score of at least 620.
FHA offers a cash-out refinancing program, which allows a lower FICO score of 600. Be aware that taking out a new FHA loan means you’ll pay for a mortgage insurance premium (MIP), including both an upfront fee and a monthly mortgage insurance fee. This increases the total cost of your new loan and digs into your savings margin.
A great option for qualified veterans and service members is to consolidate debt via a VA cash-out refinance. The VA cash-out loan allows you to refinance 100% of your home’s current value. Veterans might qualify even if they don’t have enough equity for a conventional cash-out loan.
Benefits of a Debt Consolidation Refinance
Debt consolidation can be a resourceful way to get out of debt faster. Learn more about the five benefits of using a debt consolidation refinance.
Benefit #1 – Pay only one bill every month
One of the more apparent benefits of consolidating debt with a refinance is having multiple payments lumped into one payment. This benefit is a great way to free up money monthly to save or invest in your future.
Benefit #2 – Lower your monthly payments
Debt consolidation is a way to make your month-to-month debt more affordable by paying off to reveal a lower interest rate. Lowering your monthly payments is a great way to
Benefit #3 – Improve your credit score
Consolidating your debt can also improve your credit score. It helps by lowering your “credit utilization ratio,” which is the percentage of your total credit limit that you’re using at any given time.
In general, the lower your utilization ratio, the better your FICO score.
Benefit #4 – Save money by reducing the interest paid on outstanding debt
The obvious benefit of a debt consolidation refinance is that you’ll save money by lowering the interest rate on your outstanding debts. This could save you a tremendous amount of money in the long run.
Benefit #5 – Lower your current mortgage rate to save on home loan interest
Another benefit in completing a debt consolidation refinance is to save on your original mortgage interest. By consolidating your mortgage and debts together in one, you save on interest in the long run.
Overall, a debt consolidation refinance is a smart way to pay down your debts at a much lower interest rate. But it requires a high level of discipline in making payments to avoid negative consequences.
Remember, you still owe the money
With a Debt Consolidation Refinance, you should exercise caution and be highly disciplined in your repayment. You could put your home at risk if you’re unable to make payments with your mortgage or home equity-backed loan. Loanees occasionally get into trouble because their previous credit lines are freed up when their debt is consolidated. It’s possible to rack up debt and get into trouble all over again. Remember, consolidating does not mean your debts have been “wiped clean.” They’re just being restructured to become more feasible. The ultimate goal is to stay debt-free; a refinance or loan is just a means to that end.
Next steps
Debt consolidation is a reasonable road to get out of debt for many borrowers. You will need to be aware of the possible risks in advance to avoid them and pay down your debt victoriously.
- Pursue help to get your monthly spending habits under control
- Make a higher-than-minimum payment on debts
- Contemplate a zero-interest transfer or personal loan as another option
Have mortgage questions? Trinity Oaks Mortgage proudly serves the entire DFW Metroplex. Our experienced loan officers can answer any mortgage-related questions you have and guide you through the process.
We look forward to hearing from you!
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