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Is a Cash-Out Debt Consolidation Mortgage Right for You?

What You'll Learn: Whether or Not You Should Pay Off Your Debts Using Your Home Equity.


Is a Cash-Out Debt Consolidation Mortgage Right for You?

Are you overwhelmed with debt? Getting a cash-out refinance could be the answer. With this type of home loan, you borrow more than your current mortgage and receive the excess money at closing. You can use those funds to pay off debts. Read on to discover the pros and cons of this type of debt consolidation. That way you can decide for yourself if it’s a good option for you. 

All About Debt Consolidation Mortgage Refinance 

Here’s an example of how a debt consolidation mortgage refinance works. 

Joe’s current mortgage balance is $200,000, and his home is worth $400,000. He has $50,000 of debts. These are high-interest credit cards and a personal loan that’s putting a burden on his budget. Even though he’s making good money, he doesn’t have very much extra. Plus, he’s stressed out because so much of his money is going towards high interest. 

Getting a cash-out to refinance for $250,000 can pay off his current mortgage and give him money to pay off his debts. Although his mortgage payment will be higher than his current one, the increase is slight since he’s getting a low-interest rate. 

Joe decides to apply for a cash-out refinance to get some relief. 

Here’s another quick example. Mary has $25,000 of credit card debt. She originally had 0% interest, but now the interest is over 18%, and the monthly payments are too high for her to handle. 

Her current mortgage loan has a very low-interest rate. Although she does have quite a bit of equity in her home, she doesn’t want to refinance to a higher rate just to get extra cash. Instead of doing a cash-out debt consolidation mortgage, she keeps her current mortgage and gets a home equity line of credit for $25,000 to pay off her credit cards. 

Debt Consolidation vs. Mortgage Refinancing 

There are debt consolidation loans that have nothing to do with a mortgage. Sometimes they’re called personal loans. With that type of loan, you can pay off debts and have one monthly payment instead of paying multiple lenders. The principle stays the same, but with your new loan, the payment terms change. 

The advantages are that it’s a relief to have only one monthly fixed payment, and the loan is amortized. That means at the end of the term. Your loan will be paid in full.

That’s a much better situation than having a credit card that you pay and pay and pay and never seem to make any progress because of the high interest. 

Now, let’s compare that to a mortgage refinance where you take cash out. With that type of loan, you pay off your current mortgage with a new home loan, plus get extra money to pay off your debts. Although your mortgage balance increases, you’re paying less each month since you no longer have credit cards. 

What Else Can You Do With a Cash-Out Debt Consolidation Mortgage? 

Getting a cash-out mortgage isn’t just for paying off debts. Here are some of the most common uses when a borrower receives a cash-out refi:

1.     Home improvement 

2.     Pay off credit cards 

3.     Pay off personal loans

4.     Pay off student loans

5.     Buy another property

How much cash out you can take depends on the amount of equity you have available. You don’t want your loan-to-value to exceed 80%. That’s because by keeping your LTV at 80% or lower, you avoid private mortgage insurance PMI. 

Another thing to keep in mind is that when you apply for your mortgage, the underwriter will look at your debt-to-income ratio. If your debts are too high compared to your income, the underwriter may approve your loan with the stipulation that you pay off the debts at closing. 

In that case, if you have additional money left over, you can use it any way you want. Making some home improvements could be a good idea because that can help build your equity back up. 

Pros & Cons of Home Mortgage Debt Consolidation

Ideally, you’re not burdened with debt. But when that’s not the case, it’s crucial to have a plan to get out of debt. Paying debts off can be a challenge — especially high-interest credit cards and personal loans. You could have extra money each month when you use part of your equity and pay the debts off. 

A disadvantage of a home equity type of loan is that it’s secured with your home. Personal loans and credit cards aren’t. Plus, even though the interest is lower, keep in mind if the term of your mortgage is longer — you may end up paying more interest. 

The best thing to do is know your options. Get familiar with a mortgage calculator and amortization schedule. See how much your monthly mortgage, credit cards, and loan payments are now and compare them to a new mortgage that consolidates the debts into your mortgage. 

Next, consult an amortization schedule. See how much interest you’d be paying if you refinance and compare that with what you’re paying now. Doing this will help you decide if refinancing is a good option. 

Comparing Debt Consolidation Mortgage Lenders 

Most banks and credit unions offer cash-out mortgages. Choosing the best debt consolidation mortgage lenders requires some homework and comparison. Compare rates and fees to see who offers the best deal. You’ll most likely find that Credit Unions provide lower rates. That’s because they are non-profit, and instead of paying shareholders, they invest their profits back into the credit union to offer lower rates. 

Once again, use a mortgage calculator that shows all of the costs. Third-party fees like escrow and title fees should be consistent from lender to lender. What you want to compare are lender fees for

  • Underwriting
  • Processing
  • Administrative
  • Discount points to buy down your rate

Sometimes lenders call these closing costs by different names, but they will be listed under Lender Costs on page two of your loan estimate.   

When shopping for a mortgage lender, see if they have other financial products like checking and savings accounts, equity lines of credit, and money market certificates you might be interested in. Having one institution for all of your needs makes paying bills and transferring money simple. 

Tips for Consolidating Debts Wisely

If you decide to consolidate your debts by using some of your equity, it’s essential to work out and stick to a budget. That way, you won’t over-extend yourself and get into the same situation again. But by budgeting wisely, you’ll still have money to do the fun things in life that you enjoy, plus save some cash along the way. 

Additionally, it’s a smart idea to take some of your new savings and put extra on the principal of your mortgage each month. That will pay your home loan down faster. 

If the only debts you want to pay off are high-interest credit cards, refinancing might not be your best option. Instead, check out personal loans. The interest isn’t as low as mortgage interest, but it can be lower than credit cards. 

Lastly, if your current mortgage interest is high, you can also compare getting a rate-and-term to refinance, and once that closes — get a home equity line of credit (HELOC) and use that to pay off your debt. It’s essential to work out the numbers to see what’s the best deal. 

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    1Rates are updated daily at 10:15am EST. The advertised rates and points are subject to change. The information provided is based on discount point, which equals percent of the loan amount, and assumes the purpose of the loan is to purchase a property with a 30-year, conforming, fixed-rate loan. Loan amount of $400,000; loan-to-value ratio of 75%; credit score of 760; and DTI of 18% or less. The property is an existing single-family home and will be used as a primary residence. The advertised rates are based on certain assumptions and loan scenarios, and the rate you may receive will depend on your individual circumstances, including your credit history, loan amount, down payment, and our internal credit criteria. Other rates, points, and terms may be available. All loans are subject to credit and property approval.