Should I Refinance To Pay Off Debt? A Decision Guide

Homeownership can present many opportunities, and among them is the ability to use your home equity for other purposes. For example, once you’ve built up a decent amount of equity in your home, you can use it to refinance your debt – especially high-interest debt.

You can refinance to consolidate debts from credit cards to medical debt or almost anything else – but should you? Keep reading to learn how to refinance to consolidate debt, the pros and cons and how to decide if it’s the right choice for you.

When you refinance a mortgage, you can borrow against the equity you’ve built up in your home to consolidate debt or for any other purpose. When you do this, you’re sometimes able to get a lower interest rate and lower monthly payment (though those aren’t guaranteed). For example, if you use the equity in your home to refinance a credit card debt into your mortgage, the interest rate you will be paying on that piece of debt should in most cases decrease significantly.

There are several different ways to refinance your house to consolidate debt. You can use a cash-out refinance, which allows you to replace your current mortgage with a new loan. But you can also get equity from your home without having to take out an entirely new mortgage, which we’ll talk about more later.

To help you decide whether refinancing to consolidate debt is the right move for you, let’s talk about the different types of refinance loans you might use.

Using A Cash-Out Refinance To Pay Off Debt

A cash-out refinance consists of taking out a new mortgage for more than your current loan amount. You then pay off the original mortgage and keep the cash difference. The process of qualifying for a cash-out refinance is similar to the process for any other mortgage, including the home equity and credit score requirements.

A cash-out refinance might be a good route to take if you need equity to refinance other debts or for expenses. However, it may not be the best route if you simply want to lower your mortgage interest rate since you’re ultimately borrowing more money (meaning you’ll pay more mortgage interest over the life of your loan).

Using A Rate-And-Term Refinance To Pay Off Debt

A rate-and-term refinance is a way for homeowners to get a lower interest rate on their home loans. With this type of refinance, the mortgage loan amount won’t change, but the borrower can get a lower monthly payment or even a shorter loan term. Then, they can use this lower monthly payment to put more money toward debt each month.

If you’re looking to pay less on your mortgage each month and/or pay less in interest, a rate-and-term refinance can be a great option. However, it’s not as effective if you need to get a lump sum of cash to pay toward a large amount of debt.

Using A Home Equity Line Of Credit To Pay Off Debt

A home equity line of credit (HELOC) is a financing tool that allows homeowners to borrow against their home equity only when they need it. A HELOC is similar to a credit card in that you have a credit line available when you need it, but you don’t necessarily have to use it.

Each HELOC has a set credit line based on what you’re approved for. You can borrow up to your credit limit as you want or as needed during the draw period on the loan (typically 10 – 15 years), as long as you repay the balance.

You can even borrow against your HELOC to refinance other debt. You can either repay the balance right away, or you can pay only interest for the remainder of the draw period and then repay the full balance when you enter into the repayment period.

A word of warning: HELOCs have variable interest rates. It’s possible that you could borrow money to refinance debt while your HELOC rate is low, but eventually, end up paying a higher interest rate on your HELOC than you had on your original debt.

Using A Home Equity Loan To Pay Off Debt

A home equity loan combines the features of many of the options discussed above. Like a mortgage, a home equity loan is a term loan that you borrow once and then repay over the course of many years. But instead of replacing your mortgage, you take it out in addition to your mortgage, just as you would a HELOC.

You can use a home equity loan to consolidate other debt and then repay the loan over the entire loan term, which can range from about 5 to 30 years. Like most mortgages, your home equity loan will have the benefit of a fixed-interest rate and fixed monthly payments.

If you’re considering using a refinance to consolidate debt, it’s important to understand what you’re getting yourself into. Let’s talk about some of the pros and cons of refinancing.

Pros

There are many good reasons to refinance to pay off debt, including:

• You can refinance high-interest debt to a lower interest rate. Many types of debt, including credit cards and personal loans, have interest rates that are far higher than that of most mortgages. By borrowing against your home equity at a lower rate, you can get rid of your high-interest debt and save yourself a lot of money.
• You’ll have lower monthly payments. Refinancing often results in lower monthly payments because you can get a lower interest rate and stretch your payments out over a longer period. As a result, you may have more money each month to put toward other debt.
• You can pay off your mortgage early. Refinancing doesn’t just allow you to repay your other debt more quickly – you may also be able to pay your mortgage off early. Once you get your other debt out of the way, that and your lower interest rate can help you knock out your mortgage. You may even decide to get a refinance loan with a shorter term.
• You can get cash from a cash-out refinance. A cash-out refinance allows you to borrow more than your current loan balance and get the difference in cash. You can use this money for just about anything, including consolidating debt.

Cons

While there are no doubt benefits, there are also some downsides to using a refinance to consolidate other debt, including:

• Your home becomes collateral. Because you’re using your home as collateral for the loan, you risk foreclosure if you’re unable to make your monthly payments. Losing your home simply isn’t worth getting rid of your high-interest debt.
• You have to pay closing costs. Most refinancing options require that you pay closing costs, just as you would any other mortgage. If you’re not careful, these closing costs could exceed the amount you’ll actually save in interest.
• Refinancing can affect your credit score. Taking on new debt often negatively impacts your credit score, and refinancing is no exception. Expect your credit score to take a hit for a while after you refinance your loan.
• You may end up paying more in interest. Yes, refinancing to consolidate debt can save you money on interest elsewhere. But you may also end up paying more in interest on your mortgage, even if you get a lower interest rate. Run the numbers to make sure it’s really worth it.

You’re one step closer to refinancing your mortgage to consolidate debt. Here are a few things you may want to know before you take the next step.

When should I refinance to pay off debt?

Refinancing to consolidate debt might be a good idea if you have high-interest debt and can save money by borrowing against your home equity to pay it off. However, it’s best to have a good or excellent credit score to ensure you qualify for the best interest rate.

Should I refinance my home to pay off credit card debt?

Refinancing your home to consolidate credit card debt can be an excellent option, especially because of the high interest rates that credit cards often have. However, make sure to address the initial cause of your credit card debt. If you refinance to consolidate your credit card debt, only to get back into debt, then it won’t have been worth it.

What are some alternatives to using a refinance to pay off debt?

A personal loan is an alternative to using a refinance to consolidate debt. You can also put yourself on a debt management plan such as the debt snowball or debt avalanche.

Do you lose your equity when you refinance to pay off debt?

Yes, you can lose equity in your home if you use a cash-out refinance to consolidate debt. However, you’ll gain that equity back as you repay your loan.

Refinancing to consolidate debt is a big decision. Yes, you can get a lower interest rate on your home loan while also tackling high-interest debt. However, there are also some risks, including the potential for getting into more debt, paying more in interest or even having your home foreclosed on. If you’ve run the numbers and feel confident refinancing is right for you, start the approval process today with Rocket Mortgage^®.