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Should I Refinance to Pay Off Debt or Student Loans?

What you'll learn:Reasons to consider refinancing to pay off debt

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Refinancing a mortgage can be a solution to simplify bill payments and ease some of your financial burden. Whether or not to refinance your mortgage depends on various factors. Some factors include:

  • Student loans with large payments or high interest rates
  • High interest rates on credit cards
  • Too many bills in general
  • Cash flow challenges

Should I Refinance to Pay Off My Student Loan?

Refinancing to pay off a debt really doesn't pay off the debt; it simply moves the debt from one creditor to another. There are advantages and solid reasons for doing this. One is that the current interest rates on 15- and possibly even 30-year mortgages may be lower than your student loan and other interest rates. In such cases, refinancing could make sense, but to determine if this is a good choice for you, make sure that you understand the cost of refinancing, and what that means for the length of your loan over time. Here are some things to consider when refinancing:

  • Interest Rates. What are the interest rates on the outstanding debts that you want to consolidate, and how do they compare with refinance rates you are considering?
  • Closing Costs Needed to Refinance vs. Future Interest Savings. There are costs involved with refinancing that you'll need to factor in when trying to determine if this strategy makes sense. If those costs end up exceeding your savings from consolidating your debt, you instead may want to try paying down that debt.
  • Extension of the Length of Your Mortgage. By refinancing, would you end up extending the length of your mortgage? If you have already been paying down your mortgage for at least a few years, and you refinance, you may end up resetting your loan term to 30 years. If you have a 30-year mortgage and decide to refinance to consolidate debt, you may want to choose a shorter-term loan for the new mortgage, such as one for a 15- or 20-year period.
  • Planned Length of Time in Your Home. You should consider how much longer you plan on being in your home before a potential move.

How Does Debt Consolidation Work?

Typically, your goal with debt consolidation is to pay off high interest rate loans with a lower interest rate option in order to reduce your monthly bill total and/or to save money. Sometimes a goal is to reduce your total number of debts into one loan, which can be helpful for credit purposes. As noted above, when you consolidate debt you may be lowering your monthly payment but adding to the length of your loan. That move can be a favorable strategy, particularly if your cash flow now isn't as strong as you expect it to be in the future.

What Are the Benefits of Refinancing for Debt Consolidation?

Having a number of debts can limit your available credit and negatively affect your overall credit score. By reducing the number of debts and getting further away from your credit limits on credit cards, you should see a boost in your credit score after you've started making regular payments on your new refinanced loan. That can be a big benefit! One thing that can negatively affect your credit rating is when your debt is close to your credit limit. For example, if you have a credit card with a limit of $5,000, and you have $4,500 in revolving debt on that card, not only are you likely paying a higher interest per month, but you are also negatively affecting your credit score because you are near your limit.

If you are looking at debt consolidation, you should examine all of your options, including refinancing. Your credit score, market conditions (current interest rates), and your current mortgage interest rate can all be factors that play into your decision.

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