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.
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.
There are some pros to refinancing to pay off your debt:
However, there are major downsides:
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.
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 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.
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.
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.
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