Can I use a cash-out refinance to pay off my debts?
A cash-out refinance, also know as a debt consolidation refinance, is the process of securing a mortgage for more than you owe on your home and then you take the difference in cash. Before doing this kind of refinance you will need to identify how much you need to cash out in order to pay off debts. After the calculation, you’ll want to make sure you won’t owe 80% of your home’s value after the refinance because if you do, you’ll need to buy mortgage insurance.
For example, if you owe $100,000 on your home that is worth $200,000, and you’d like to pay off $10,000 in other debt, here is how you would calculate that:
(100,000 + $10,000) / $200,000 = 55%
In this scenario, you will not need to purchase mortgage insurance since your loan-to-value ratio is below 80%. The benefit here is that you can pay off your high-interest debts and take advantage of mortgage interest rates which are usually lower than credit cards debt. Doing this at a time when mortgage rates are low is ideal.
Considerations for Cash-Out Refinance
Monthly Mortgage Payment: Since you are increasing the loan amount you have left to pay, your mortgage payment will likely go up. You may be able to help offset some of this by refinancing when mortgage rates are low.
Closing Costs: In most cases, refinancing for a lower rate and/or to secure funds for paying off other debts, will require some closing costs to complete the refinance. This could range from hundreds to thousands of dollars money which could be used to pay off debts now. You’ll need to consider the break-even point on how long it would take before you recoup these costs and see if it is a viable option.
Long-Term Planning: You will need to make sure that if you plan to do a cash-out refinance to pay off other debt, that you won’t be acquiring any new debts in the near future. If you pay off existing debts, but fall right back into debt again, now you may have a higher mortgage payment in addition to debt. Do some planning and projections to make sure you won’t have any major purchases on the horizon that could result in an increase in your debt.