Take Control Of Debt With A Mortgage Refinancing
Prices for consumer goods and property are ever-increasing. This poses a challenge for the majority of
Americans since real wages have barely budged over the last decade, something which has resulted in a sharp increase in consumer debt among individuals.
While many debt management solutions exist, homeowners have a unique set of options available for refinancing their debt. Here we will look at how homeowners can use the equity in their home to get their debt under control.
Some types of debt, such as credit cards and personal loans, may carry high-interest rates that make it difficult to keep up with payments.
Those borrowers in this situation often look to debt refinancing to make payment easier and less expensive.
While there are many different ways to accomplish this goal, they all involve paying off current debts with a secondary loan.
Ideally, this secondary loan will come with a lower interest rate and more favorable terms, thus allowing the recipient to better manage their debt.
How Mortgage Refinancing Can Help Eliminate Debt
A cash-out refinancing loan involves taking out a second mortgage that’s slightly larger than the remaining balance on the first mortgage.
The extra cash is then used to pay off all outstanding debt. Because mortgages are fairly low-risk loans for banks, they come with a lower interest rate than other types of loans.
Let’s say an individual has a $300,000 mortgage at 3.99% and $50,000 in credit card debt with an average interest rate of 19.99%.
They can take out a cash-out refinancing loan for a total of $350,000, using $300,000 of the loan to pay off their first mortgage and $50,000 to pay off their credit card bills.
While they still owe the $50,000, the debt carries an interest rate of 3.99% instead of compounding at 19.99%.
Who Is Eligible For Mortgage Refinancing?
Owning a home doesn’t guarantee approval. Lenders look at several criteria when determining whether to approve an applicant or not.
- Loan To Value Ratio: Most lenders will not grant more than 75% of the home's market value. This means that homeowners should have at least 25% equity in their homes to qualify.
- Credit History: Although a cash-out refinancing loan is a fairly low-risk loan for lenders, they still look for applicants to have a decent credit score and stable financial situation.
- Time In Residence: Most mortgage lenders will add a clause to the contract which stipulates a minimum amount of time a borrower must own their home before they can refinance the mortgage.
How To Apply
- Determine How Much Debt To Pay Off: Cash-out refinancing uses the equity in one’s home to consolidate their high-interest debt. Before applying, a borrower must know exactly which debt and how much they wish to refinance.
- Apply At Several Lenders: Most application processes can be completed online using the pre-approval process. This will help the applicant realize what they qualify for within a short time frame.
- Compare Options And Decide On A Loan: It’s important to not look solely at the interest rate, but also at the fees and other costs associated with a loan. Once the best choice is determined, a borrower must formally accept the offer.
The Refinancing Pros & Cons
- Lower Interest Rates: Because mortgages are low-risk loans that are secured by a property, they come with lower interest rates than other loans. This can be especially helpful for those who use a cash-out refinancing loan to pay off high-interest debt.
- Reduces Cost Of Debt: The lower interest rates will dramatically reduce the overall cost of an individual's consumer debts.
- Increases A Credit Score: A cash-out refinancing loan can result in an improved credit score by allowing the borrower to be more consistent with their monthly payments.
- Foreclosure Potential: Should the recipient fail to repay their loan in full, it can result in the bank foreclosing on their home. Although it can be convenient to use equity to pay off one’s credit card bills, it’s essentially trading unsecured debt for secured debt.
- Could Increase Debt Problems: Paying off one’s credit card debt with a cash-out refinancing loan is only a smart idea if the borrower doesn’t start using their credit card again. Irresponsible spending will leave the borrower with more debt than they started and with fewer options to get out of debt.
A cash-out refinancing loan is a viable debt management solution because it gives the recipient access to low-interest credit which they can use to consolidate their high-interest debt.
Those borrowers considering this route should make sure they have the debt management skills necessary to not fall back into debt.