Pros and Cons of a Debt Consolidation Mortgage Refinance

A debt consolidation refinance may let you kill two birds with one stone: It can allow you to achieve a lower interest rate on your debt while streamlining all your monthly payments into one. You’ll essentially consolidate debt obligations and roll them into your mortgage, but at a much lower interest rate. The result is a single payment at a lower interest rate: your monthly mortgage payment. 

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How It Works

A debt consolidation refinance allows you to pay off high-interest credit cards, medical bills, student loans, and any other loan balances you carry. This is done by borrowing a larger amount than what you owe on your home. The difference is used to pay off debt. 

You can opt for a debt consolidation refinance as long as you have at least 20% equity in your home. You’ll also have to qualify for this program, at which time your lender will look at your credit score, job history, and debt-to-income ratio, among other factors, just as they would when you’re buying a home.

Debt Consolidation Options

Cash-out refinance

This is typically a good option for homeowners with high loan balances and perhaps not a super low rate on their current mortgage. 

The new loan will pay off the initial mortgage, while the remaining funds will pay off debt. Sometimes the new lender will pay that debt directly, and sometimes they’ll issue the borrower cash to pay it off themselves. If the rate on the current mortgage isn’t competitive, this is also an opportunity to lower the rate on the outstanding balance at the same time.

Rate and term refinance

A rate and term refinance is exactly what it sounds like: The new loan comes with a lower interest rate and a longer term, as you’re starting over with a new 30-year mortgage.

This is a great way to combat high interest rates, especially if those rates have made it difficult to make your monthly mortgage payments. The extra cash you’re not paying toward your mortgage payment is then used to help pay down your outstanding loan amount associated with credit cards, medical bills, and other loan balances.

Home equity line of credit (HELOC)

A HELOC allows you to borrow against the equity in your home without touching your current mortgage. This is terrific if you closed your loan at a great rate but still need to access your equity. The amount you borrow can be used to pay off loan balances. A HELOC works differently from a regular mortgage in that you pay as you use it.

The Advantages of a Debt Consolidation Refinance

There are pros and cons to a debt consolidation refinance. You can pay off high-interest debt, often in a shorter period of time. Your credit score will also benefit, as it can grow as your debt shrinks. The money you save with your new lower interest rate can also be put toward your debt consolidation efforts, allowing you to pay off these loan balances faster. 

One of the biggest advantages to knocking down this debt is the fact that you’ll have some breathing room. Consolidated debt opens your credit cards back up, providing a cushion in case of emergencies. Speaking of emergencies, you can also use the money you’re saving every month to build up your rainy-day fund—that way you won’t have to rely on credit cards in the first place. 

And let’s not forget about convenience. Every loan amount has a different due date, interest rate, and balance. A debt consolidation mortgage can simplify this process with one payment, an interest rate that’s much more favorable than high-interest credit cards, and a lower amount due overall (when you take into consideration all your debts and interest). 

Things to Consider with a Debt Consolidation Refinance

Naturally, since you’ll be borrowing more than your current mortgage balance, your monthly mortgage payments will be higher. When you’re thinking of the pros and cons of debt consolidation refinance, think of it this way: Yes, your monthly mortgage payments will be higher, often by a few hundred dollars. But with a lower interest rate and only one payment, the savings can outweigh the cost. 

Still, you need to make sure this is a monthly payment you can afford. A debt consolidation refinance will also mean you’re paying more mortgage interest over the life of the loan—though, again, you have to weigh that against high-interest credit cards. And you cannot deduct mortgage interest tied to your other outstanding debts.

Another thing to consider is how long you’re planning to stay in your home. A debt consolidation refinance can make sense if you’re planning to stay for a while. If you’re not, you’ll have less equity in your home when you decide to sell, which means less money in your pocket. This new loan will likely be for 30 years, so you’ll want to make sure you’re comfortable with its terms. 

A debt consolidation refinance also comes with fees. Closing costs will typically amount to between 2% and 6% of your loan.

Tapping into home equity can be a smart way to tackle other debts, particularly as U.S. homeowners with mortgages saw their equity increase by 15.8% year over year from the third quarter of 2021. Unfortunately, credit card balances are also higher than ever, with the Federal Reserve Bank of New York noting that total household debt increased by $312 billion (2%) in the second quarter of 2022. 

Put these two facts to work for you by using your home equity to pay down credit cards, medical bills, and other loan balances. APM is happy to show you how; give us a call today.