The Pros and Cons of A Debt Consolidation Refinance

A debt consolidation refinance can be a valuable option when you’re looking to manage and pay off high-interest debts like maxed-out credit cards, car loans, or other substantial debts relative to your income. However, before committing to this financial move, it’s crucial to weigh the advantages and disadvantages of obtaining a larger mortgage to eliminate existing debts.

What is a debt consolidation Refinance?

A debt consolidation mortgage involves borrowing more than your current mortgage balance and using the surplus funds to settle outstanding debts such as car loans, student loans, or credit card balances. Keep in mind that specific programs allow you to borrow varying percentages of your home’s value.

How does a debt consolidation Refinance work?

This financial strategy operates similarly to a cash-out refinance and may even be referred to as a debt consolidation refinance. Essentially, you borrow more than your current mortgage balance but allocate the cash towards paying off other debts. Typically, these credit accounts are cleared during the closing process.

However, it’s essential to undergo a financial assessment to ensure you can comfortably manage the increased mortgage payment. Additionally, you’ll need a home appraisal to confirm the equity in your property, as most loan programs only permit borrowing up to 80% of your home’s value.

Types of debt consolidation mortgages

Several options are available for debt consolidation, including:

• Conventional cash-out refinance: Suitable for borrowers with a credit score above 620 and a stable employment history. You can borrow up to 80% of your home’s value without incurring monthly mortgage insurance.
• FHA cash-out refinance: Designed for borrowers with lower credit scores (as low as 500), backed by the Federal Housing Administration. While it allows borrowing up to 80% of your home’s value, it requires upfront and annual mortgage insurance premiums.
• VA cash-out refinance: Exclusive to eligible military borrowers, offering the potential to borrow up to 90% of your home’s value without mortgage insurance. However, a VA funding fee may apply.
• Home equity loans: A second mortgage that doesn’t affect your existing mortgage. You receive a lump sum with fixed-rate payments and terms ranging from five to 15 years.
• Home equity lines of credit (HELOCs): Similar to a credit card, providing flexibility to borrow as needed during a “draw period.” Payments are initially interest-only and must be repaid in installments after the draw period.
• Reverse mortgages: Available to homeowners aged 62 or older with substantial home equity. Unlike traditional mortgages, no monthly payments are required, but the loan balance accumulates over time, diminishing home equity.

Pros and cons of a debt consolidation mortgage

Pros:

• Pay off high-interest-rate credit cards.

• Potential for improved credit scores.

• Allocate savings to reduce the higher mortgage balance.

• More financial flexibility to avoid future credit card use.

• Build up an emergency fund with savings.

Cons:

• Higher monthly mortgage payment.

• Increased overall mortgage interest payments.

• Inability to deduct mortgage interest related to debt payoff.

• Risk of foreclosure if new mortgage payments become unaffordable.

• Typically, higher interest rates and closing costs.

Debt Consolidation Refinance Example

Below is an example of a how much you would save with a debt consolidation refinance. You new mortgage amount would be $400,000 paying off $50,000 worth of credit card and personal loans. The new mortgage amount includes your existing mortgage amount of $350,000 for a home that is worth $600,000. Your current credit card and personal loan payments add up to $1,333.00 and your current mortgage principal and interest payment is $2,568.18.

• Current Mortgage Payment: $2,568.18
• Monthly Debt Payments: $1,333.00
• Mortgage and Debt Payments: $3,901.18
• New Mortgage Payment: $2,935.06
• Total Monthly Savings: $966.12

In the example above refinancing into a higher interest rate can be have an amazing effect finances. Think about how having a additional $300, $500, or $1,000 back in your pocket at the end of every month could change your current financial position.

Alternatives to debt consolidation mortgages

If you’re concerned about securing debt through your home, consider these alternatives:

• Personal loans: Borrow a smaller, unsecured amount at a potentially higher interest rate.
• Debt management plans: Offered by credit counseling organizations to consolidate unsecured debt, though approval may take longer and involve negotiations with creditors.

Always weigh your financial situation and goals before deciding on debt consolidation or alternative methods. 

There are pros and cons of a doing a debt consolidation mortgage. Speak with a great loan officer that can do a debt consolidation analysis to see if a refinancing is a beneficial for your situation and to see if what your potential monthly savings can be.

At MacLagan Home Loans, Alex MacLagan and his team specialize in doing debt consolidation refinances.