People with high-interest credit card debt, car loans, or student loans often think about consolidating their debt. So, let’s discuss debt consolidation via a cash-out home refi to see if it makes sense for you.
How a cash-out home refinance works
A cash-out home refinance involves replacing your current mortgage with a new mortgage and receiving a lump-sum cash payout. This cash comes from your home’s equity, which is the difference between the current market value of your home and the amount you owe on your current mortgage.
For example, if your house is currently worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 in home equity. Lenders might allow you to borrow a portion of that $100,000, and turn it into cash to consolidate other debts.
The upsides of debt consolidation
The biggest benefit of a cash-out home refinance is realized if the interest rate on your new mortgage is lower than the interest rate of the debts you wish to consolidate. This is often the case with high credit card debt because the interest rates are typically much higher than the interest rates on mortgages.
The idea is to pay less interest over time by borrowing money at a lower interest rate to consolidate existing debts with higher interest rates. However, before using your home’s equity to consolidate higher interest debt, you should consider whether you can pay off the higher interest debt more quickly than the term of your refinance.
Debt consolidation can also simplify your bill paying process since you’ll only one bill to track and one due date to remember.
Look at the whole picture before you decide
Debt consolidation with a cash-out home refinance can make sense if you save money over time and can handle the new mortgage payment. Do the math carefully so you are sure the savings are worthwhile and be sure to consider the closing costs associated with a refinance into your calculations as well.
Also keep in mind that financial advisors typically do not recommend borrowing more than 80% of the loan-to-value (LTV) ratio of your home. Borrowing more than 80% may trigger the need to buy private mortgage insurance (or “PMI”), which is an additional monthly expense.
How to get started when you’re ready
Many people consult an expert to help them understand the upsides and downsides of debt consolidation for their finances.
Once you’ve decided a cash-out home refinance makes sense for you, give this a read: The Prep Work, Process, and Payoff of a Cash-Out Refi.
Ditech is not a financial advisor and the ideas outlined above are for informational purposes only. They are not intended as investment or financial advice and should not be construed as such. Consult a financial advisor before making decisions regarding important personal financial matters, and consult a tax advisor regarding the deductibility of interest and tax implications.