Refinance To Pay Off Debt: What To Know

If you’re working to pay off debt, it can be helpful to use the tools at your disposal, including your home. If you have significant equity in your home, you may be able to refinance and turn some of your home equity into cash to help pay off debt at a lower rate. This can be especially helpful in the case of high-interest debt.

While refinancing to pay off debt is an option, it’s not the right option for everyone. It’s important to consider your unique financial situation, including the terms of your current mortgage and the type of debt you have, to determine whether refinancing is a good idea for you.

Can You Refinance A Mortgage To Consolidate And Pay Off Debt?

The short answer is that yes, you can refinance your mortgage to pay off debt. Refinancing is when you take out a new mortgage to replace your current one. Your new loan has an entirely new interest rate, repayment term and monthly payment.

There are a few different ways to refinance your home to pay off debt, including a cash-out refinance, rate-and-term refinance or government refinance.

In addition to being able to pay off your debt, there could also be other benefits to refinancing. Depending on your current loan terms and the terms of your new loan, you may be able to lower your interest rate or monthly payment, ultimately saving you money in the long run, even with the costs that come with refinancing.

How To Refinance Your Home To Pay Off Debt

There are a few different methods to refinance your home to pay off debt. Each of these loan types has different advantages and may be best suited to a particular type of borrower.

1. Cash-Out Refinance

A cash-out refinance is when you take out a new mortgage for more than your current loan. You use a portion of the refinance loan to pay off your original mortgage and receive the difference in cash. For example, if you have a mortgage balance of $150,000 and take out a refinance loan of $200,000, you’ll potentially be able to pay off your original loan and get $50,000 in cash.

A cash-out refinance may be a good option if you have a large amount of debt – especially high-interest debt – and want to pay it off quickly. However, this option won’t be available to borrowers with limited home equity. Additionally, it isn’t a good option if your goal is to lower your mortgage payment since a larger loan could instead result in a higher payment.

2. Rate-And-Term Refinance

A rate-and-term refinance works a bit differently from a cash-out refinance in that you’re taking out a new loan in the same amount as your current mortgage. You’ll be able to repay your current loan fully, but there won’t be any additional amount to get in cash.

Instead of getting cash to pay off your debt, the goal of a rate-and-term refinance is to lower your interest rate and monthly payment. And because you’re paying less toward your mortgage each month, you have more money available to put toward other higher-priority debt.

A rate-and-term refinance isn’t ideal for borrowers who won’t qualify for a lower interest rate or monthly payment since that defeats the purpose of refinancing in the first place. Additionally, it may not be the right choice for borrowers with a very high amount of high-interest debt they want to pay off quickly.

3. Government Refinance

If you have a government-backed loan, you have the option of using a government refinance instead of a conventional refi. Some options available include:

• Federal Housing Administration (FHA) Streamline Refinance: An FHA streamline refinance allows you to refinance an existing FHA loan without going through the full credit documentation and underwriting process.
• Department of Veterans Affairs (VA) IRRRL Streamline Refinance: Formally known as an Interest Rate Reduction Refinance Loan, a VA streamline refinance. As with the FHA refinance, the VA refinance also allows for a more streamlined process.

These refinance loans are ideal for existing government-backed loan borrowers, especially those who have less-than-ideal credit since it won’t necessarily affect their eligibility. However, you can’t take cash out with either of these loan options (with the exception of $500 from the FHA streamline refinance).

Pros And Cons Of A Refi To Consolidate Debt

There are some clear benefits to refinancing your home to pay off debt. However, it’s not the right choice for everyone, and there are some downsides to consider.

Pros

• Lower interest rates: When you refinance your loan, you have the opportunity to get a lower interest rate, which reduces the overall cost of your mortgage.
• Potential for lower monthly payments: Depending on the type of refinance loan and the interest rate you qualify for; you may be able to get a lower monthly payment.
• Pay off debt quicker: Refinancing your mortgage can help you pay off debt more quickly, whether it’s in a lump sum from a cash-out refinance or in small monthly increments after a rate-and-term refinance.

Cons

• Your home becomes collateral: When using a cash-out refinance to pay off other debt, you’re using your home as collateral. If, for some reason, you can’t make your monthly payments, you risk losing your home.
• Potentially longer repayment period: Refinancing to pay off debt could require that you extend your loan term, meaning it will take longer to become mortgage-free.
• Pay fees and closing costs: A refinance loan requires fees and closing costs, just like any other mortgage. In some cases, you may not actually save money on the interest from your other debt because of these costs.

Is Refinancing To Pay Off Debt A Good Idea For You?

As we’ve established, refinancing your mortgage to pay off debt can be a great idea for some borrowers. It allows you to pay off high-interest debt quickly while also possibly getting a lower interest rate and monthly payment on your mortgage.

When you’re debating whether to refinance to pay off debt is the right choice for you, here are a few factors to consider:

• Qualifications: When you refinance your mortgage, you’ll have to meet certain loan qualifications, just as you did when you took out your original mortgage. Qualifications include your credit score, debt-to-income ratio and more.
• Market conditions: The current market conditions have a major impact on what your refinance loan will look like, largely because of their impact on mortgage rates. If rates are high, it may not be the right time to refinance.
• Long-term financial goals: It’s important to consider your long-term financial goals when deciding to refinance. On one hand, refinancing can help you pay off debt, freeing up more money for other goals. On the other hand, it could mean it takes longer to repay your mortgage.
• Amount of equity: Lenders generally require that you have at least 20% equity in your home to refinance – and that’s after any money you take from a cash-out refinance. If your equity is too low, refinancing may not be an option.
• New monthly payment: It’s important to consider what your new monthly payment will be and it’s comfortably within your budget. With a rate-and-term refinance, you would ideally have a lower payment. But with a cash-out refinance, your monthly payment may end up being higher. Make sure you can afford it.
• Closing costs: Just like any other mortgage, a refinance loan requires closing costs. It’s important to make sure you have money set aside for those costs and that the money you’ll save on your other debt by refinancing exceeds the money you’ll spend on those added refinancing costs.

Refi To Pay Off Debt: FAQs

Before deciding to refinance to pay off debt, make sure to read the answers to these frequently asked questions.

When should I consider refinancing to help pay off debt?

It could make sense to refinance your home to pay off debt if you have high-interest debt that will take a long time to pay off if you don’t refinance and if you have significant home equity you can pull from. Ideally, it’s also best to wait until you have good credit, so you qualify for the best interest rates.

What are some alternatives to refinancing to pay off debt?

If refinancing isn’t the right choice right now, there are other loans available to help you consolidate your debt. A home equity loan or line of credit still allows you to tap into your home equity to pay off debt. Additionally, a personal loan could be a useful debt consolidation tool.

Can I use my home equity to pay off debt?

Yes, you can use your home equity to pay off debt. You can do this either by doing a cash-out refinance or by using a home equity loan or home equity line of credit. Just remember that when you use your home equity to pay off debt, the debt is secured by your home. If you can’t make your payments, you could lose your home.

The Bottom Line

Homeownership comes with plenty of benefits, including the ability to tap into your home equity or restructure your mortgage to pay off high-interest debt. This move isn’t right for everyone – it’s best for those with good credit and significant home equity. But if you qualify for a good rate, it could help save you a lot in interest. If you’re considering refinancing to pay off debt, start on your refinance application today to see if you qualify.