With credit card interest rates averaging well over 24% in 2024, one increasingly popular option is refinancing a mortgage to pay off debt. This strategy can offer significant benefits if you are looking to consolidate debt, but it’s crucial to evaluate whether or not it makes sense for your unique financial situation.
What is Refinancing to Consolidate Debt?
Mortgage Refinancing involves replacing your existing home loan with a new one, usually to secure better terms or rates. When it comes to consolidating debt, there are two primary types of refinancing to consider:
Cash-Out Refinance
Allows you to borrow more than you owe on your home and take the difference in cash to pay off other debts. For example, if you owe $300,000 on your mortgage and you’d like to pay off $50,000 in other debt such as credit cards, auto loans, or other loans, you would take out a $350,000 mortgage.
Rate and Term Refinance
Focuses on obtaining a lower interest rate or changing the loan terms without taking out additional cash.
Situations where refinancing might be beneficial include high-interest debt consolidation, lowering monthly payments, or securing a better interest rate.
What do you need to get a cash out refinance to pay off your debt?
Having sufficient home equity is vital when considering refinancing. The Loan-to-Value (LTV) Ratio is a key metric lenders use to assess your eligibility.
For FHA and conventional loans, the maximum loan amount you can take is 80% of your property’s value (80% Loan-to-Value).
Meanwhile, VA loans allow you to take up to 100% of your property’s value.
Home Equity
Having sufficient home equity is vital when considering refinancing. The Loan-to-Value (LTV) Ratio is a key metric lenders use to assess your eligibility.
For FHA and conventional loans, the maximum loan amount you can take is 80% of your property’s value (80% Loan-to-Value).
Meanwhile, VA loans allow you to take up to 100% of your property’s value.
Credit Score
Lenders typically require a credit score of at least 620 to approve a cash-out refinance. However, the better your credit score is, the more favorable terms you can secure on your new loan. A good credit score also demonstrates responsible financial management and makes you less risky as a borrower.
Note: If you don’t have an excellent credit score or enough home equity, consider applying with a co-borrower who meets these requirements.
Debt-to-Income Ratio
Your debt-to-income (DTI) ratio is another factor that lenders consider for refinancing. It is the percentage of your monthly income that goes towards debt payments, including your new mortgage payment.
Most lenders prefer a DTI of 45% or lower, but some may go up to 57%. Keeping a low DTI shows you have enough income to cover all your debts and are less likely to default on your loan.
Qualifying for a debt consolidation refinance
Credit Score and Debt-to-Income Ratio (DTI)
Lenders typically require a good credit score and a manageable Debt-to-Income Ratio (DTI). A higher credit score can help you secure better terms, while a lower DTI shows lenders you can manage your new mortgage payments alongside your existing debt.
Appraisal and Home Value
A home appraisal determines your property’s current market value, which influences your loan terms and eligibility. Higher home value can lead to better refinancing conditions.
Costs Associated with Refinancing
Refinancing comes with various costs, including:
- Closing Costs: Fees for processing the new loan
- Insurance Premiums: Homeowners insurance and potentially PMI
- Application and Origination Fees: Costs associated with applying for and originating the new loan
- Third Party Costs and Taxes: Fees for services like appraisals, title searches, and recording fees
Mortgage Refinance Options
Conventional Cash-Out Refinance
This option allows you to take out a new conventional mortgage for more than you owe and use the extra cash to pay off other debts.
Benefits include potentially lower interest rates compared to other debts, and eliminate mortgage insurance if you are currently paying PMI or have an FHA loan.
FHA Cash-Out Refinance
With an FHA loan, you can also tap into your home’s equity and pay off other debts. This type of refinancing requires mortgage insurance, which could offset some of the savings on interest rates. However, FHA loans allow homeowners with lower credit scores and high debt to income ratios to be able to qualify.
VA Cash-Out Refinance
The VA Cash-Out Refinance is a beneficial option available to veterans and active-duty service members, allowing them to convert their home equity into cash.
This program not only enables borrowers to pay off existing debts but also provides an opportunity to secure a lower interest rate on their mortgage. Unlike FHA loans, VA loans do not require private mortgage insurance (PMI), which can result in significant savings.
VA loans allow veteran homeowners to tap up to 100% of the property’s value, making it the only loan that allows it.
Non-QM Cash-Out Refinance
Non-Qualified Mortgage (Non-QM) cash-out refinance options provide flexibility for borrowers who may not meet the traditional mortgage criteria. These loans cater to those with unique financial situations, such as self-employed individuals or those with irregular income streams, allowing them to leverage their home equity.
Non-QM loans include but are not limited to Bank Statement loans, P&L loans, DSCR loans, 1099 loans and more.
Alternative loans to access equity from your home
Home Equity Lines of Credit (HELOC)
A Home Equity Line of Credit (HELOC) allows homeowners to borrow against the equity in their homes in the form of a second mortgage.
Unlike traditional loans, a HELOC operates similar to a credit card, providing a revolving line of credit that can be utilized as needed, up to a predetermined limit based on the homeowner’s equity. This flexibility enables borrowers to tackle various expenses, such as home renovations, educational costs, or even unexpected emergencies.
Typically, HELOCs come with variable interest rates, which can affect monthly payments. Additionally, many lenders offer interest-only payment options during the draw period, providing potential financial relief during the initial borrowing phase. One of the main benefits of taking out a HELOC is that it doesn’t change the terms of an existing mortgage.
Home Equity Loans (HELOAN)
A Home Equity Loan (HELOAN) is a lump-sum loan that allows homeowners to borrow against the equity they have built up in their properties.
Unlike a HELOC, which offers a revolving line of credit, a Home Equity Loan provides a fixed amount upfront with a predetermined repayment schedule, making it easier for borrowers to budget their monthly payments. These loans typically come with fixed interest rates, providing stability for borrowers throughout the life of the loan.
Alternative Debt Repayment Methods
Personal Loans
Using personal loans to consolidate debt can offer fixed interest rates and clear repayment terms. However, they often come with higher interest rates compared to mortgage refinancing.
Balance Transfer Credit Cards
0% Introductory APR credit cards can provide temporary relief from high-interest debt, but be wary of the balance transfer fees and the high rates after the introductory period ends.
401(k) Withdrawals
Tapping into your retirement savings might seem like a quick fix, but it comes with significant tax implications and can jeopardize your long-term financial stability.
Ready to see if refinancing is right for you? Explore your options with Andes Mortgage and talk to one of our licensed professionals about refinancing.
Schedule a call with us by clicking this link here or give us a call at 770-740-4050
