Refinance Your Mortgage To Pay Off Your Debt: Do It Right
NOTE: Due to the coronavirus outbreak, refinancing can be a bit of a challenge. Lenders face high demand for loans and staffing challenges. If you can’t pay your current home loan, check out our mortgage aid Resource. For the latest information on how to cope with financial stress during this emergency, see NerdWallet’s COVID-19 financial guide.
Some homeowners refinance themselves to pay off debts, such as credit card balances. They accomplish this with cash refinancing: getting a mortgage for more than what they owe on the house, taking the difference in cash, and paying off high interest debts.
Consolidating credit card debt using cash back refinance allows you to make fixed payments over a period of time, rather than paying a revolving balance each month. As an added bonus, mortgage rates are generally lower than credit card interest rates.
“When you refinance with cash, you increase your mortgage balance by the amount of other debt you are paying off.“
Using a cash refinancing to pay off credit card debt is also known as a debt consolidation refinance. You end up owing the same amount, but you pay off high interest credit card debt and replace it with low interest mortgage debt.
Can You Refinance To Pay Off Your Debt?
Before you refinance a mortgage to pay off debt, you need to make sure you have enough equity. If you end up owing more than 80% of the value of your home after refitting, you will need to purchase mortgage insurance.
To avoid owing more than 80% of the home’s value, you’ll need to calculate your loan-to-value ratio. It’s simple: divide your mortgage balance by the approximate value of your home.
(Current mortgage amount) / (approximate home value) = loan / value ratio
If you want to cash out some of the equity in your home to pay off your debt, add the amount of debt you are paying off to the loan amount, as follows:
(Current mortgage amount) + (account balance to be repaid) / (approximate home value) = loan / refinancing cash ratio
Here’s an example: Let’s say you owe $ 200,000 on a house worth about $ 300,000 and you would like to pay off $ 15,000 in debt. Your calculation would look like this:
($ 200,000 + $ 15,000) / $ 300,000 = 0.7167 or about 72%
Since your loan-to-value ratio is less than 80%, you can take out enough equity to pay off your debt without having to pay mortgage insurance.
How closing costs figure in your decision
Closing costs are another factor to consider before refinancing to pay off debt. Lenders and service providers charge hundreds or thousands of dollars in fees when you refinance a mortgage. It is money that you could otherwise use to pay off your debts. Compare the closing costs with the overall interest savings on the consolidated debt. You want the interest savings to exceed the closing costs.
In other words, it may be a good idea to spend $ 3,000 on mortgage closing costs to save $ 12,000 in interest, but not to save $ 2,000 in interest.
Is refinancing to consolidate debt a good idea?
First of all: before debt consolidation, you’ll want to have a plan to avoid getting into debt again.
Credit card debt is unsecured, which means it is not backed by collateral. If you don’t pay what you owe, the credit card company can’t bring your home. In contrast, mortgage debt is secured by your home, so the lender can take your home if you stop making payments. This means that when you pay off credit card debt with mortgage debt, you increase the risk of losing your home.
When you refinance with cash, you increase your mortgage balance by the amount of other debt you are paying off. Even if you refinance with a lower mortgage rate, your monthly payments may increase, depending on the interest rate and the terms for which you qualify.
Consider the length of your mortgage – the length of the loan in years. If you’ve already paid off your mortgage for several years, you probably don’t want to extend it again to 30 years. Instead, consider shortening the term to 25 or 20 years. This strategy reduces the total interest payments over time, even though it leads to a higher monthly payment.
Explore all of the available options and find the loan that best suits your needs and goals.
Always know the equity in your home
Tying your mortgage to NerdWallet lets you know how much you could cash out on refinancing.