Drowning in debt? High interest rates could be the culprit. High-interest debts, like credit card and personal loan debt, can really eat away at your bank account. For many people, though, that’s just the beginning. Don’t forget about the interest rates on your biggest debt: your mortgage. How to use a mortgage refinance to get out of debt
By freeing up more money in your budget, you could pay down your other debts faster and possibly even pay off your mortgage earlier as well. In other words, a mortgage refinance could be the answer to your debt problems.
Here’s what you need to know when using a mortgage refinance to get out of debt.
Make sure you meet the criteria
Before you can even consider a mortgage refinance to eliminate debt, you must make sure you qualify to get the best results. Typically, lenders will evaluate your application based on three key factors: home equity, income, and your credit.
Just like when you initially applied for a mortgage, lenders will weigh your monthly income and debt payments to determine your debt-to-income (DTI) ratio. Some lenders may be flexible, but a DTI no higher than 38% is usually the standard.
It also makes a big difference if you have equity in your home, which is the home’s value minus your existing mortgage. You’ll need at least 20% equity in order to be considered for a refinance with a desirable interest rate.
Finally, your credit plays a big role in whether or not you qualify, and what you qualify for. If you’re interested in refinancing your mortgage, you’ll need good credit in order to be offered the best interest rates.
So, check your full credit report prior to applying. You can easily do so through sites like myFICO and freecreditreport.com. Make sure to clear up errors on your report and continue to make on-time payments on your bills and existing debts.
Determine if you’ll really save money
Over the past five years, mortgage rates have hit record lows; 30-year mortgage interest rates reached as low as 3.69% in March 2016. When you compare that to the national average credit card interest rate of 15.59%, there is clearly some room to save money and potentially give yourself a 10%+ return if you were to refinance your mortgage and consolidate your debt.
To get a better idea of how much you can truly save by refinancing your mortgage, consider which debts you wish to pay off and what their currents rate are. Then, compare rates from other mortgage lenders and consider any extra costs and fees you may incur as a result of financing.
Keep in mind that extra fees and closing costs could eat into your savings. However, you may not even incur any depending on which lender and their terms.
Dan Green, a mortgage expert for the past 15 years, recommends that buyers ignore the old adage that claims you need to save one percentage point on your refinance, or it’s not worth it.
That advice was solid in the 1960s when loan sizes were small, closing costs were high, and people never moved. Today, with zero-closing cost mortgage options, it can be smart to get a new loan anytime you can save money and pay no closing costs to do it.”
Dan explains, “That advice was solid in the 1960s when loan sizes were small, closing costs were high, and people never moved. Today, with zero-closing cost mortgage options, it can be smart to get a new loan anytime you can save money and pay no closing costs to do it.”
Melissa Thomas, author and financial coach, also found this to be true. She and her husband refinanced their mortgage and saved an average of $400 per month, which helped them pay off $43,544 in consumer debt in less than four years. Their consumer debt included two car loans, six maxed out credit cards, and two student loans.
“We had a no closing cost refinance, so I would recommend looking for that option as you compare lenders and offers because that means refinancing won’t cost you any out of pocket money,” Melissa says.
“If that is not an option for you, you have to weigh out how much money you will save by refinancing and paying closing costs vs. not refinancing and keeping your debt as is.”
Consider a cash-out refinance
If you qualify for a mortgage refinance to eliminate debt and would benefit from the savings, consider a cash-out refinance to consolidate and pay off your other debts.
We had a no closing cost refinance, so I would recommend looking for that option as you compare lenders and offers because that means refinancing won’t cost you any out of pocket money”
A cash-out refinance involves getting a new loan with a slightly lower interest rate for a larger amount than the existing mortgage loan. As the borrower, you receive the difference between the two loans in cash to use as you please.
In this case, you’ll be using the cash to pay off your high-interest debt like credit cards, a car loan, or a personal loan.
For instance, say you own a home valued at $250,000 and still owe $150,000 on the mortgage. You’ll have built up $100,000 in equity. You need an extra $25,000 to pay off some credit card debt and a car loan.
You can get a cash-out mortgage refinance with a new loan for $175,000 ($150,000 loan you’ll still owe on your home via mortgage payments, plus $25,000 cash).
With this strategy, you can consolidate debt into a home loan and pay it off at a much lower interest rate.
Borrow against the equity in your home
Another option would be to get a home equity loan or line of credit to pay off debt.
A home equity loan allows you to use your home equity as collateral to borrow a fixed amount of money. You’ll receive the money upfront, which you then have to make payments on (typically over a period of-of 15 or 30 years, for example). The amount of equity in your home will determine how much you qualify for, as will your payment term, income, and credit history.
A home equity line of credit (HELOC) allows you to borrow against the equity in your home for a fixed period. It’s a revolving line of credit (usually a percentage of your home’s equity) that allows you to access money when you need it. Similar to a credit card, you can borrow what you need, pay off the balance, and then borrow again.
Remember, the amount of equity you have in your home equals the market value of your home, minus what you owe. Using our example above, let’s say you have $100,000 in equity and would like to borrow some of that value to pay off your high-interest debt.
You can apply for a HELOC and be given a period of time where you can withdraw the funds you need on an ongoing basis, just like with a credit card. The only difference is that you won’t be required to make payments immediately. You can start paying back the funds you borrowed after the draw period has ended.
This gives you some time if you are knee deep in debt and need some quick relief. HELOC’s tend to have an adjustable interest rate, but the interest is tax deductible.
If you’re struggling to pay off high-interest debt, refinancing your mortgage can be a smart move to consolidate your debt and pay it off faster while spending less money overall. However, it is a personal decision and, ultimately, your goal is to save money and make the debt payoff process easier.
Mortgage interest rates are at an all-time low, and you can take advantage of that by using any of the options mentioned above.
To find the best option for your situation, compare rates and terms from top mortgage refinance lenders now.
Or you can start by checking out these top 7 mortgage refinance lenders.
Before you make your final decision, stop by SuperMoney’s mortgage refinance page to compare rates and terms from top lenders so you can narrow down your options and make the best decision for your needs and situation.