Americans have a lot of debt. As of mid-2019, U.S. borrowers owed a total of $1.4 trillion in student loans and another $1.07 trillion in consumer credit card debt. And then of course there’s the $1.28 trillion in auto loan debt. Add in first and second mortgages, home equity loans, boat and RV loans, medical bills and personal loans and it's clear that many Americans are carrying a heavy debt burden. If you are a homeowner and fall into that category, you might consider consolidating your debts by refinancing your mortgage.
What is Consolidating?
Consolidating your debt means taking out one big loan to pay off all your other debts. Then you will make only one debt payment each month, simplifying your bill paying process. If you are able to get a lower interest rate on your consolidated loan, you can end up saving money as well. In order to consolidate your debts with a mortgage, you would apply for a cash-out refinance. This means paying off your existing mortgage with a new loan and using some of your equity to pull out cash to pay off your other debts.
Why is Refinancing to Consolidate a Good Idea?
Most kinds of debt have higher interest rates than mortgage loan. For example, credit cards can carry rates between 13% to 23%. By consolidating with a cash-out refinance loan, you could have one simple debt payment that carries a much lower, more affordable interest rate. Over the life of your loan, you could end up saving tens of thousands of dollars in interest.
Is It a Good Idea for Me?
Consolidating your debt with a mortgage loan makes the most sense if you have plenty of home equity and you can get a lower interest rate. If your cash-out refinance brings your loan-to-value (LTV) ratio higher than 80%, you will then be required to pay private mortgage insurance. PMI can tack hundreds onto your monthly mortgage payment and negate any consolidation savings. To calculate your current LTV, divide your mortgage loan balance by the appraised value of your property. For example, if your you owe $215,000 and your home is worth $300,000, your LTV would be 0.72 or 72%. To figure out wat your LTV would be after a cash-out refinance, add the money you need to pay off your other debts to your current loan balance. Say you have $20,000 in other debts, then you would divide $235,000 by $300,000 to get an LTV of 78%.
Other Considerations
A cash-out refinance loan does not erase your other debts, it merely shifts them into one big loan. This will make your monthly mortgage payment higher. In some cases, it may be better to keep a smaller debt with a higher interest rate and just pay it off as quickly as possible.
Also, you may be putting yourself at higher risk of default on your home if your mortgage payment increases by too much. If you get behind on your credit card debt, the lender cannot foreclosure on your home, but if you consolidate your debt and then cannot make the full payments, you could lose your home.
Refinancing for loan consolidation can be great way to save money and simplify your finances. It may not be the right choice for everyone, but you can consult a trusted mortgage professional to see if it makes sense for you.