Debt Consolidation Refinance: What Is It? Is It the Best Option For You?

A debt consolidation loan is a type of mortgage refinance that allows homeowners to borrow more than what is owed on their current mortgage, using the difference to pay off other large debts, such as credit card balances, car loans or student loans. This type of mortgage works similarly to a cash-out refinance but with the added benefit of consolidating high-interest debts into a single, more manageable payment.

By consolidating debts into a mortgage, homeowners can avoid accumulating more debt from high-interest loans. Instead, they can take advantage of lower mortgage interest rates to streamline their monthly expenses and lower their overall financial burden.

It’s important to note that most loan programs only allow homeowners to borrow up to 80% of their home’s value through a debt consolidation refinance. For example, if a homeowner has a $200,000 home with a current mortgage balance of $150,000, they could potentially borrow up to $40,000 in a debt consolidation mortgage.

Here’s an example scenario:

Bob and Mary have accumulated $30,000 in credit card debt with an average interest rate of 15%. They have a mortgage on their home with a current balance of $200,000 and a 4% interest rate. By obtaining a debt consolidation mortgage, they could potentially refinance their mortgage for $230,000, pay off their credit card debt and still have a similar monthly mortgage payment. This would result in a significant reduction in their overall interest payments and allow them to simplify their finances by combining all of their debt into one payment.

To be considered for a debt consolidation mortgage, you must qualify for the new loan. This means you need enough home equity to pay off your existing debts, as most loan programs only allow you to borrow up to a certain percentage of your home’s value. Typically, significantly more than 20% equity is needed in order to qualify for underwriting a debt consolidation mortgage.

For example, if your home is worth $300,000 and your current mortgage balance is $200,000, you may only be able to borrow up to $40,000 through a debt consolidation mortgage if you have 30–40% equity. This amount is typically referred to as the cash-out limit, and the specific amount you can borrow will depend on your lender’s policies and the loan program you choose.

In addition to having sufficient equity, debt consolidation mortgages typically require a credit score of at least 620. However, if you’re interested in an FHA cash-out refinancing program, you may be able to qualify with a lower FICO score of 600.

If you’re a veteran, you may be able to cash out up to 100% of your home’s equity with a VA cash-out refinance. This program is designed specifically for military service members and their families and offers more flexible requirements and lower interest rates than traditional mortgage loans.

There are several benefits to consolidating your debts through a mortgage refinance. A debt consolidation loan can help you achieve all of the following:

• Pay off high-interest-rate credit cards and loans — By using the equity in your home to pay off high-interest-rate debts, you can substantially reduce your monthly payments and the overall amount of interest you pay in the long term.

• Improve your credit score — When you combine your debts, your credit utilization ratio decreases, which can have a positive impact on your credit score.

• Apply the savings to your principal to pay down the high balance sooner — By applying the money saved on interest payments to your principal, you can pay off the higher balance faster and save even more money over time.

• Less need for credit cards with more room in your budget — With a debt consolidation mortgage loan, you’ll have more disposable income each month, which can help you avoid turning to credit cards for unexpected expenses.

• Use the savings to build up an emergency fund — By paying off high-interest debt and lowering your monthly payments, you can use the savings to build up an emergency fund, which can provide a financial safety net in case of unplanned expenses or job loss.

• Have an overall lower monthly debt payment — A debt consolidation mortgage can help you lower your monthly debt payments, which can help you manage your finances more effectively and reduce financial stress.

If a debt consolidation mortgage doesn’t sound like the best option for you, there are other routes you can consider.

• Home equity line of credit (HELOC), which enables you to borrow against the equity in your home to pay off high-interest debts. One of the drawbacks of a HELOC is that it uses your home as collateral, putting it at risk if you’re unable to make your payments. Additionally, HELOCs often come with variable interest rates that can rise over time, leading to higher payments and potentially making it difficult to budget for the loan.

• Balance transfer credit cards, which can provide a promotional interest rate for a certain period of time to consolidate your debts. One of the disadvantages of using a balance transfer credit card is that the 0% introductory interest rate may only last for a limited time, after which a higher interest rate will apply. Additionally, some credit cards charge a balance transfer fee, which can add up to the overall cost of consolidating your debt with this option.

• Debt management plans, especially for those who don’t qualify for a debt consolidation mortgage loan due to low credit scores or collections on their credit report. However, a debt management plan may take longer to pay off debt, and it may negatively impact your credit score.

• Personal loan, which typically carries higher interest rates than debt consolidation mortgages but does not put your home at risk if you can’t make the payments.

Q: How often can I refinance my home?

A: There isn’t a limit to the number of times you can refinance your home, but you will need to consider the costs associated with refinancing.

Q: How much will it cost to refinance?

A: Closing costs will vary depending on the lender, location and amount of the loan. Costs typically range from 2–6% of the loan amount.

Q: How can refinancing help me consolidate my high-interest debt?

A: When you refinance, you can take out a new mortgage for more than what you currently owe. You can then use the difference to pay off your high-interest debts. This can help simplify your finances and may even save you money in the long run.

Combining your debts through a debt consolidation mortgage loan can be a smart financial move for some homeowners. If you’re interested in consolidating your debts and want to learn more, contact the team at Blue Water Mortgage to explore your options. Our experienced agents can help you understand the process and make informed decisions that protect your finances. Submit a form today to start the refinance process.

Sources

Experian, “A Debt Management Plan: Is It Right For You?, https://www.experian.com/blogs/ask-experian/credit-education/debt-management-plan-is-it-right-for-you/.”

Experian, “All You Need to Know About Balance Transfer Credit Cards, https://www.experian.com/blogs/ask-experian/what-are-balance-transfer-credit-cards/.”

Experian, “Pros and Cons of Personal Loans, https://www.experian.com/blogs/ask-experian/pros-cons-personal-loans/.”

TransUnion, “Credit Card and Personal Loan Balances Reach Record Levels as Consumers Navigate High Inflation, Rising Interest Rates, https://newsroom.transunion.com/credit-card-and-personal-loan-balances-reach-record-levels-as-consumers-navigate-high-inflation-rising-interest-rates/.”

United States Department of Veterans Affairs, “Cash-out Refinance Loans, https://www.va.gov/housing-assistance/home-loans/loan-types/cash-out-loan/.”