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If you have equity in your home, you may wonder if it's possible to refinance to pay off debt. You may be able to do this through a cash-out refinance. But just because you can refinance, it doesn't mean you should. Here's what you need to know about refinancing to pay off debt and why it may be a high-risk strategy.
Can you refinance your mortgage to pay off other debts?
If you have enough home equity to qualify for a cash-out refinance loan, you may be able to refinance to pay off debt.
When you take a cash-out refinance loan, you borrow more than you currently owe on your home. You can then use the extra cash to repay debt. If you owe $150,000 on your home, you might be able to take a $200,000 cash-out refinance loan. You could use the extra $50,000 to pay off credit card debt or other bills.
You must qualify for a cash-out refi based on income, current debt, credit score, and other financial factors. Bear in mind you will have to pay closing costs to refinance, just as you did with your original mortgage loan.
Most refinance lenders limit you to borrowing 90% of your home's current value or less. If your property is worth $200,000, this could mean your maximum loan amount is $180,000. And if you borrow more than 80% of your home's value, you'll likely need mortgage insurance, too.
Is refinancing to pay off debt a good option?
There are some pros to refinancing to pay off your debt:
- Mortgage refinance rates are generally lower than those of other debts.
- Mortgage interest may be tax deductible if you itemize.
- Repayment could be simplified. You'll have just one monthly mortgage payment instead of multiple monthly payments. And you may lower your monthly payment.
However, there are major downsides:
- You're putting your home at risk and likely converting unsecured debt to secured debt. Let's say you fall behind with a personal loan or credit card payment. It's certainly not ideal and will damage your credit score, but you won't lose your home. But if you fall behind on a mortgage payment, you could lose your home.
- You could pay more interest in total, even if you snag a lower interest rate. This is because you'll likely lengthen your payoff timeline.
- You could end up owing more than your home is worth. This could make it difficult to sell or refinance in the future.
Ultimately, you're taking a huge risk by refinancing to pay off debt. It may be worth it, but be aware of the downsides. Consider other debt consolidation alternatives such as a debt consolidation loan before you do a debt consolidation refinance.
Will refinancing to pay off debt fix my finances?
Refinancing to pay off debt will not fix your finances. It may not even be the best answer when determining how to pay off debt.
That's because you aren't actually paying off existing debt. You're simply moving it around. You need to be confident you can make your new monthly mortgage payments and live within your means to avoid getting deeper into debt again. Otherwise, you could make your financial situation much worse.
You can improve your financial situation when you refinance to pay debt if the following are true:
- You qualify for a lower mortgage rate than your current mortgage.
- You can substantially reduce the interest on the debt you're refinancing.
- You will make all payments on time.
- You'll avoid consumer debt in the future.
Still have questions?
Here are some other questions we've answered:
The Ascent's best mortgage refinance lenders
Refinancing your mortgage could save you hundreds of dollars for your monthly mortgage payment and secure you tens of thousands of dollars in long-term savings. Our experts have reviewed the most popular mortgage refinance companies to find the best options. Some of our experts have even used these lenders themselves to cut their costs.
FAQs
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You can refinance your mortgage to pay other debts if you qualify for a cash-out refinance loan. Generally, you will need sufficient equity in your home so your total loan balance is below 90% of your home's value. Ideally, it should be below 80% to avoid private mortgage insurance. You must also qualify for a cash-out refinance loan based on your income, credit score, and other factors.
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Refinancing to pay off debt is a good idea if you can substantially reduce your interest rate and are committed to avoiding future debt. You also need to consider the repayment timeline. If you make your payoff time much longer, the interest could cost more over time -- even if you drop your rate. That's because you'll be paying it for longer.
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Refinancing to pay off debt won't fix your finances. At times, it can make debt repayment cheaper and easier, which can help you improve your financial situation. But you'll still need to commit to living within your means and avoid borrowing in the future. If you refinance without a plan in place, you could make your financial situation much worse.
Our Mortgages Expert
Christy Bieber is a full-time personal finance and legal writer with more than a decade of experience. She has a JD from UCLA as well as a degree in English, Media and Communications with a Certificate in Business Management from the University of Rochester. In addition to writing for The Ascent and The Motley Fool, her work has also been featured regularly on MSN Money, CNBC, and USA Today. She also ghost writes textbooks, serves as a subject matter expert for online course design, and is a former college instructor.
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