With today’s low interest rates, refinancing your mortgage has been all the rage. Lowering your monthly mortgage payment seems like a no-brainer, but did you know you can consolidate your debt by refinancing too? If you have steady and predictable income but want to save money and make paying off your debt simpler, a debt consolidation refinance could be a great option for you. The current climate of low rates and high home values makes now the perfect time to consider this.
What is a debt consolidation refinance?
A mortgage refinance is when you get a new mortgage loan for your home, typically with a lower rate, a shorter term, or both. A debt consolidation or cash-out refinance, however, is when you refinance your mortgage for more than your current balance and borrow against the equity of your home to get cash out. You can then use that cash to pay off other, higher interest debts like credit cards, medical bills, student loans, or anything else. Essentially you transfer your higher interest debt into your mortgage.
How does it work?
To understand how this works, we need to discuss equity. Equity is the difference between what you owe on your mortgage and how much the home is worth. Therefore, when home values rise, people typically gain equity in their home. A debt consolidation refinance or a cash-out refinance allows you to tap into your earned equity to access cash and pay off debt.
Curious how much equity you have in your home? Check out this handy tool, Homebot.
Here’s a hypothetical situation: you bought a house for $200,000 with a $180,000 loan. Five years pass, and now you owe $160,000 on the mortgage. The home has also appreciated and is worth $300,000, which means you hypothetically have $140,000 in equity. Most lenders allow you to access up to about 80% of that equity, depending on the specific situation of the borrower. When you refinance and pull cash out to consolidate, the equity is used to pay off other debts, or it can be distributed as cash for you to allocate how you’d like. You will literally receive a check for the amount you choose to take out of your equity. The amount available to borrow depends on the specific situation of each borrower.
What is the benefit?
Given that mortgage rates are fixed and have been trending around 3-4%, mortgages are one of the least expensive ways to borrow money. Paying off your credit card debt that has 18-29% interest can save you a significant amount of money and minimize your bills. Additionally, mortgage debt is secured, and your payment will be the same over time whereas a credit card bill is variant and compounds depending on how much you choose to pay each month.
This can save homeowners money by paying lower interest on the monthly mortgage payment and your bills with high interest. By paying off your high-interest consumer debt with one, lower interest loan, paying off debt can be more affordable and manageable.
It is important to note that this does not make your debt disappear. You are still paying it off, just at a much lower interest rate of 3-4% rather than a typical credit card rate between 18-25%. This can save you money and improve your monthly cash flow by eliminating excess bills. Another perk is that mortgage interest is typically tax-deductible but other consumer debt is not.* While this refinance option is not meant to be an escape from debt problems, it can be a win-win situation when used as part of a responsible plan to manage your finances.
*consult with a certified tax professional for details.
Did you know you can consolidate your debt by refinancing?