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Debt Consolidation Mortgage Refinance Explained

November 1, 2021

7 MINUTE READ

Did you know that only 23% of Americans can claim to be debt-free?

With interest rates at historical lows, a debt consolidation mortgage refinance could be the way forward for your finances. While a debt consolidation refinance may put your home at risk, it could enable you to pay off higher-interest debts immediately.

Let’s look at debt consolidation mortgage in more detail to determine if it’s a suitable option to eliminate your debt obligations.

How Does Debt Consolidation Work?

The concept of debt consolidation is a simple one. The general idea is taking out one lower-interest loan to pay off multiple high-interest loans. When utilized correctly, consolidation has the following advantages:

  • One easy repayment every month
  • Removal of crippling interest fees
  • Lower costs in the long term

However, although debt consolidation may sound enticing, it’s not suitable for everybody. You may need to examine your current financial situation and assess whether consolidation is the right move.

Consolidating Debt with a Mortgage Refinance: Types of Refinancing

Mortgage consolidation is a type of debt consolidation. The way it works is you take out a new mortgage on your home. You can use the funds to pay off other debts. Then, you pay off the larger mortgage over time. Since this is a secured loan type, you risk losing your home should you stop making payments. If a home loan consolidation sounds like the right option for you, there are multiple ways to do it.

Cash-Out Refinance

Cash-out refinancing is one of the most common types of consolidation. Homeowners use the equity they’ve built up in their homes to take out cash to pay off other debts.

When you undergo a cash-out refinance, you increase your mortgage balance. In addition, you’ll receive a lump sum to pay off any other debts. Homeowners often use this form of refinancing to pay off the higher interest rates on credit card debt.

Rate and Term Refinance

Another way to refinance to consolidate debt is to opt for a rate and term refinance. This type of mortgage refinancing allows you to alter the terms of your current loan, ideally for more favorable ones. Technically, you are taking out a completely new mortgage. The value of the new mortgage will pay off the old one. Many homeowners did this after the 2008 housing crisis when interest rates crashed.

Home Equity Loan

A home equity loan is another form of debt consolidation refinancing. Often referred to as a second mortgage, a home equity loan leverages the equity in your home. Most lenders require an independent appraiser to value the property to determine your possible loan amount. Cashing in some of your equity is an easy way of consolidating your debt.

Home Equity Line of Credit (HELOC)

A HELOC works similarly to a standard home equity loan. The difference is HELOCs are a type of revolving debt.

For example, you have $100,000 in equity in your home. A HELOC taken out against this equity means you have $100,000 to do with as you please. You can utilize your line of credit at will.

The typical length of a HELOC is ten years. Every time you spend using your HELOC, you are required to pay it back. There are no limits to how often you can utilize a HELOC as long as you keep paying the outstanding amount back. The simplest way to view a HELOC is a credit card secured against your home’s equity.

Debt Consolidation Considerations

Before looking into a debt consolidation mortgage refinance, there are several considerations to take into account. The following ones will determine not only your eligibility for certain types of debt consolidation refinancing, but whether it’s a smart move for your financial situation.

Interest Rate

The primary advantage of a debt consolidation home loan is paying off high-interest debt with a low-interest loan. For example, paying off credit card debt with a 30% interest rate using a home loan with a single-digit interest rate may be a smart move. Due to historically low interest rates, home loan consolidation may be advantageous to the borrower.

Equity

Most of these loan options hinge on the equity you already have in your home. For example, no lender will allow you to take out a home equity loan of $50,000 if you only have $5,000 of equity built up. Work out your current equity value and decide whether this is a viable option. Many lenders will require you to have a minimum amount of equity built up first.

Mortgage Term

Consider the term on your mortgage. If you’ve already spent 15 years paying off a 30-year mortgage, are you willing to start off at a 30 year term again? Perhaps consider a shorter mortgage term, where your overall interest paid will be lower despite higher mortgage payments.

Monthly Repayments

Compare your current debt service payments to how much you would pay per month with a refinance home loan debt consolidation plan. If there’s little difference between your monthly repayments, it may not make much sense to take out a mortgage consolidation loan.

Should You Refinance Your Mortgage to Consolidate Debt?

Although home loan consolidation is a powerful financial tool, it’s not the best move for everybody. Therefore, it’s important to weigh up the pros and cons before committing to any financial move.

Pros

  • Fewer Monthly Payments – Debt consolidation refinance enables you to roll your loans into one single monthly repayment.
  • Fixed End Date – Making the minimum credit card payment could mean paying down your outstanding loans for years to come. A debt consolidation mortgage has a fixed end date.
  • Lower Interest Rate – In this era of historically low interest rates, refinancing via your mortgage will likely come with a lower interest rate.
  • Mortgage Interest Tax Deduction – Consolidating your debts into a mortgage may enable you to take the mortgage interest tax deduction annually.

Cons

  • Adding Years to Your Debt – Mortgages are structured to last for 15-30 years. Therefore, debt consolidation could extend your overall debt repayment time.
  • Low Credit Score – Without a high credit score, you may not receive favorable refinancing terms.
  • Secured Loan – Mortgage refinancing loans are secured against your home. A secured loan means that if you fail to repay it, you could lose your home.
  • Closing Fees – There are closing fees involved in refinancing, which means if you lack liquidity, you may not be able to afford it.

Debt Consolidation Mortgage Refinance FAQs

If you have any questions about mortgage refinancing, get in touch with Reali Loans to learn more. But, before you do, check out the answers to some of the most common questions below.

How Does Refinancing Help Me?

The average credit card interest rate in the U.S. is 30%, whereas the average mortgage interest rate is just 3-4%. However, be aware that refinancing will typically come with longer debt repayment periods than a credit card.

What Is Home Equity?

To work out your equity, take the home’s appraised value, or current market value and subtract the outstanding mortgage amount. For example, if your home is worth $500,000 and you still owe $300,000 on your mortgage, your home equity is $200,000.

What About Closing Costs?

Closing costs do apply when opting for a home loan consolidation. However, these tend to vary between lenders across the country. Costs typically range between 3% and 6% of the total loan value, which can take years to recoup through repayments. If you lack liquidity, you may be able to roll your closing costs into the mortgage and reduce out-of-pocket costs.

How Often Can I Refinance?

To protect the borrowers’ interests, some states limit how often you can refinance a mortgage. Even if your state has no limitations, it’s important to discuss your options with a loan professional before taking this step.

The Bottom Line

Refinancing your mortgage could be the right choice for you if you’re servicing high-interest debts. Speak to Reali about unlocking some of the equity built up in your home. Our dedicated home loan officers will help you determine if this type of transaction is right for you.