Refinancing Your Home Loan: Debt Consolidation Loans and Cash-Out Refinance
Are you feeling financially squeezed with the amount of bills coming your way each month? Refinancing your home loan with a cash-out refinance could be a great way to get the money you need to consolidate all those bills and get rid of their high interest charges.
What is Cash-Out Refinance?
So, what is a cash-out refinance and how will it help consolidate your debt?
Let’s start by defining a cash-out refinance. While a typical mortgage refinance alters the rate and term of your mortgage (and thus is known as a “rate-and-term refinance”), a cash-out refinance increases the actual amount borrowed. You are then able to pay off your existing mortgage entirely (and thus can continue paying your mortgage off to your new creditor at the same rate-and-term or an altered one) and you receive a lump cash sum for the increased amount borrowed. Thus the name, “cash-out refinance.”
This money can be used for many purposes, such as home improvements. These improvements could increase the home’s value and make it more enticing to potential buyers when the owners eventually sell their home. Paying for increasingly expensive college tuition is another common reason, as is paying off credit-card debt or financing a new business endeavor. However, many homeowners use their cash-out refinance in order to consolidate their existing debts from credit cards, education loans and more.
Debt Consolidation Refinance with Cash-Out Refinancing
By using the cash from your cash-out refinance to pay off your existing credit card debts, you are essentially transferring all your debt into one place: your mortgage. A debt consolidation refinance gets rid of differing due dates and various companies you owe to, putting all your loans and debt into one, easy to remember payment.
The benefits don’t stop there, however. The interest rates on mortgages are generally substantially lower than on credit cards: As of September 2018, the average interest rate for a 30-year fixed rate mortgage was 4.7% while the average interest rate for a credit card that same month 17%. So, by paying off a higher mortgage rather than credit card debt, you are saving potentially hundreds of dollars each month.
However, it’s important to know that your ability to undergo a cash-out refinance depends greatly on your home equity. You generally need at least 20% equity in the property in order to be eligible to qualify for a cash-out refinance.
What is Home Equity?
Determining your home equity is relatively easy. Home equity is simply the difference between how much your home is worth minus how much you still owe on your mortgage. It’s basically your ownership interest in your home.
For example, say you bought a home for $200,000, made a down payment of $20,000 and borrowed $180,000. Five years down the road, you’ve paid $13,000 of your mortgage off, you still owe $167,000, and your home’s value has increased to $220,000. To determine your equity, you take what your home’s current value is ($220,000) and subtract the amount that’s still owed ($167,000) – in this case, your home equity would be $53,000.*
Then, divide $53,000 by the $220,000 your home is worth and you discover that you have over 24% home equity, making you likely eligible to qualify for a cash-out refinance.
What to Consider when Consolidating your Debt
Even after securing a debt consolidation loan, it’s important to keep in mind that your debt isn’t gone; it’s just in a new place. You need to remain disciplined in your spending and not overspend on your now “debt-free” credit cards.
Another thing to consider is that it is almost never a good idea to secure a cash-out refinance at an interest rate that’s higher than the one you’re paying right now. If you find that is not possible, then there are other options you may want to consider – home equity loans, reverse mortgages, or a home equity line of credit (HELOC).
Also, make sure you’ll be able to afford the new payments on your new mortgage. When undergoing a cash-out refinance, the balance of your mortgage increases by the amount of debt that you are paying off. As a result, your monthly mortgage payment may wind up increasing, depending on the terms you qualify for as well as the rate of interest.
Additionally, as of January 1, 2018, tax laws regarding refinancing have changed. While originally the interest paid on a cash-out refinance was fully tax-deductible (up to $100,000) with the new laws, this only applies if the cash-out is used to buy, build, or improve your home. Using the money to consolidate debt, however, is not fully tax-deductible.
To see if debt consolidation refinancing and cash-out refinancing is right for you be sure to talk to one of our home loan experts to see if this form of home loan refinancing is right for you.
Why Choose Proper Rate for your Refinance
With low rates, personalized debt consolidation loan options and unbeatable service, you’ll be sure to get the mortgage and low rate you need to meet all of your home financing goals.
Recommended Loan Options for Refinancing
*Sample ‘future’ rate provided for illustration purposes only and is not intended to provide mortgage or other financial advice specific to the circumstances of any individual and should not be relied upon in that regard. Proper Rate, LLC. cannot predict where rates will be in the future.
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