Refinancing your home to pay off high-interest debt is just like any other financial decision — there are pros and cons that should be seriously considered before taking the leap.
For many homeowners in Maine, the benefits outweigh the disadvantages, but everyone’s financial situation is unique. Here is a breakdown of the pros and cons to give you a better idea of your options.
The Pros of Debt Consolidation Through Refinancing
Many homeowners choose to refinance to take advantage of the following benefits:
- Lower Interest Rates: Consolidating high-interest debts — especially credit cards, which have interest rates between 15% and 20% — can give you a much lower interest rate. Credit cards can also come with penalty rates and late fees that can result in even higher monthly payments.
- Single Monthly Payment: By consolidating your debt into a single monthly payment, you’ll avoid the stress of keeping track of multiple payments. In addition, you are less likely to miss payments if you only have one.
- Tax Deduction: Your debt may not be tax deductible but the interest on your mortgage payment is.
- Improved Credit: Since your high-interest debt will be paid and on-time mortgage payments are viewed favorably by credit rating bureaus, your credit rating could very well improve after refinancing.
The Cons of Debt Consolidation Through Refinancing
Not everyone will be able to refinance in order to pay off debt. You’ll need to have a certain amount of equity in your home and/or qualify for a low enough interest rate to make the process worth it.
If you are able to find a refinancing option, the relief that comes with tackling a substantial amount of debt could possibly have adverse effects. It’s not uncommon for homeowners to improve their credit profile and then start accumulating new debt right away.
Because of the possibility of debt relapse, it’s important that homeowners are financially responsible if they choose to refinance. Establishing a strict budget and sticking with it will require a strong level of commitment.
Also, if you use your home equity to pay off debt, you’ll be back to square one in terms of paying off your home. This can take the option of moving or renovating off the table for a bit.
Your Debt Consolidation Options
Now that the advantages and disadvantages have been explained, here’s what you need to know about the two most common refinancing options: a home equity line of credit (HELOC) and cash-out refinancing.
If your goal is to pay off your debt right away and perhaps do other things such as a home renovation in the near future, a HELOC could be a great option since you only pay interest on the money you use.
A HELOC is typically taken out in addition to your existing mortgage, so it’s considered to be a second mortgage. Its terms and repayment schedule will be different from that of your first mortgage. If you happen to own your home outright, you may be able to take out a HELOC as your first mortgage. The interest rate on a HELOC is variable and typically follows the U.S. Prime Rate.
A cash-out refinance mortgage loan works well if you plan to immediately use the full amount of cash you are borrowing, since you will start paying interest on it as soon as you receive it.
Cash-out refinancing involves taking out a new loan on your home for more than you owe for it. The difference between what you actually owe and what you borrowed goes to you in a lump sum of cash. This loan pays off your existing mortgage and will not have the same terms as your old mortgage. The interest rate for cash-out refinance loans is usually lower than that of a HELOC since it’s typically fixed.
Want to explore your debt consolidation options? Contact our team! We’ll help you understand your home’s value and determine if a HELOC or cash-out refinancing loan is a good option when it comes to achieving your financial goals.