Refinancing for Debt Consolidation: Is It Worth It?

There are many reasons to refinance your mortgage. Many homeowners refinance to lower their interest rate and save on monthly payments. Or, you can change the term of your mortgage to prioritize paying it off sooner. Refinancing can also be useful for eliminating private mortgage insurance or changing from an adjustable-rate mortgage (ARM) to a fixed-rate mortgage. But one of the best uses of a refinance is to access your home’s equity and get cash out.

This cash can be used however you want, from paying for important purchases to financing an education. You can also use this money to pay off other open accounts, like credit cards and personal loans. This is a process known as consolidating debt since you are combining existing debt into a new loan with a single monthly payment. There are great advantages to refinancing a home loan to consolidate debt, but there are a few drawbacks to be aware of as well. As with any financial decision, it is important to decide based on your personal situation. Take a look at the pros and cons of refinancing to consolidate debt and see what you think.

Pros of refinancing to pay off debt

The main reason that homeowners may choose to consolidate debt by refinancing is to save money. Credit cards and personal loans typically carry higher interest rates than mortgages do. So, by paying off the balance with money from a cash-out refinance, you can effectively transfer the balance to a lower-interest account.

There are other reasons to consider refinancing to consolidate debt. These may include:

• Simplifying bill payments: It is much easier to keep track of just one monthly payment. No need to remember multiple due dates and login credentials, and you can look forward to throwing out less paper mail, too!

• Lowering your mortgage rate: A cash-out refinance is like a Swiss Army knife. You can use it so many different ways. And one of its core tools is locking in a lower interest rate for your home loan payments.

• Improving your credit score: By paying down (or paying off) your credit card debt, there is a good chance you will notice an eventual bump in your credit score. Remember, it will go down momentarily from the hard credit pulls required to refinance, but over time you will likely be better off.

Cons of refinancing to consolidate debt

Keep in mind, refinancing to consolidate debt is not for everyone. It is a big step to take and will require an investment of time, energy, and money for closing costs. Homeowners should always consider the downsides before making a decision.

Some of the potential drawbacks include:

• Putting your home on the line: Unlike personal loans or credit cards, the money you borrow from a cash-out refinance is linked to your house. That means if for some reason you default on your payment, you may be at risk of foreclosure.

• Delaying your mortgage payoff: Depending on the terms of your cash-out refinance, you may extend the length of time it takes to pay your mortgage back. This could get in the way of your future financial goals, like retirement and long-term savings.

• Losing equity: By converting your home’s equity into cash, you will be lowering (or depleting) the equity you have built up. It can be rebuilt over time, but it will take time—and should be avoided if you plan on moving again any time soon.

How to consolidate debt by refinancing

If you do decide that the rewards outweigh the risks, you can feel good about moving forward with a cash-out refinance. The process is almost identical to any other type of refinance. You will want to shop around for the best rate, consult your existing lender to see what deals they may offer, and then fill out the required paperwork to get pre-approved.

Just like when you first obtained your mortgage, you will need to provide your financial information, schedule an appraisal, agree to the terms, close on the deal, and wait for the funds to transfer. The whole process can typically take from 45 to 60 days.

Then, once you have the funds in hand, you can pay off your higher-interest accounts. Just make sure to not start building up that debt again, or the whole process will be for nothing!

Alternatives to consolidating debt with a refinance

If a cash-out refinance does not feel like a good match for you, there are plenty of other options for consolidating your debt and saving on interest. Consider one of these alternatives:

• Home Equity Line of Credit (HELOC): A different way to access your home’s equity. Instead of collecting one lump sum, you can take out as much as you need during a draw period and pay it back over time without affecting your current mortgage.

• Personal loan: Depending on the current market conditions, you may be able to get a personal loan with a lower rate than any you currently have. There are a lot of variables involved, but it could be worth looking into.

• Balance transfer card: If you are only carrying a few thousand dollars in high-interest debt, you may be able to get away with using a balance transfer card. Typically, these credit cards feature 0% APR for a limited time, so if you are able to plan your payments and limit your spending, it is possible to save on interest.

Remember, if you ever have any questions about your home finances, or need help managing debt, it can be valuable to talk it over with your lender. They may be able to offer personalized assistance and make recommendations based off your unique financial situation.