Cash-Out Refinance for Debt Consolidation

Have you ever wanted to know some fascinating facts about Google paired with finance and real estate trends? If so, you’ve come to the right place.

According to Internet Live Stats, Google processes more than 40,000 search queries every second on average, which amounts to over 3.5 billion searches per day. And one of the top questions people are asking the search engine as it relates to mortgages?

“Should I cash-out refinance to consolidate debt?”

The fact is, Americans are extremely burdened by debt. In fact, Debt.Org says each household in the country carries an average of more than $8,300 in credit card debt, and total U.S. consumer debt has ballooned to $13.86 trillion. That includes things like auto loans, mortgages, credit cards, and student loans.

It’s why cash-out refinance for debt consolidation is on the minds of many homeowners as a means to ease the financial burden.

What is a Cash-Out Refinance?

Some homeowners refinance their mortgage via a simple rate-and-term loan in order to do just that — get a better rate. But others choose a cash-out on their home equity in order to pay off debt.

It sounds a bit like an oxymoron, right? Reduce the equity in your home by getting a new mortgage for more than you owe, then pocketing the difference in cash and using it to pay off other high-interest debt.

That’s the gist of it.

But a cash-out refinance isn’t something you should decide on quickly or spontaneously. For one thing, you need equity built up in your home to even consider it. There are also so-called ‘seasoning’ rules to adhere to, which means you won’t even qualify for a cash-out refi unless you’ve lived in the home for a year.  And above all, there are very strict limits on the amount of money you can actually receive in a cash-out refi (known as a loan-to-value ratio, or LTV).

According to Bankrate, the current gold standard on LTV is 80% of your mortgage equity for FHA (and most government-backed loans) and possibly up to 85% on conventional loans depending on the lender. There’s likely no getting around it, as the numbers are an industry-standard, which means you can only borrow so much of your home’s current value.

Keep in mind that a cash-out refi does a lot more than change your interest rate or the terms of your loan. It takes equity in your home and reduces it in order for you to use that money for something else.

For many homeowners, that something else is to consolidate their debt.

Cash-Out Refinance and Debt Consolidation

If you have significant unsecured debt (loans not backed by collateral) — amounting to perhaps thousands of dollars or more — then a cash-out refinance may be the best way out of your financial black hole. That’s because a cash-out refi may help you save on interest and reduce your monthly payments. It may even help you eliminate that debt completely.

This is literally the best reason to trade one debt for another — because mortgages offer much lower interest rates than credit cards. According to The Balance, the average credit card interest rate in February 2020 was  21.28%, up slightly from the previous month. At the same time, 30-year mortgage refinance rates were around 3.560%. You don’t have to be good at math to know that’s a tremendous savings.

It’s not just credit card interest rates that are high. Value Penguin says the national average for auto loan interest rates is around 5.27% on 60-month loans.  (And typically, the annual percentage rate, or APR, for auto loans, ranges from 3% to 10%. Imagine carrying that 10% interest on a $50,000 car). Meanwhile, NerdWallet sayspersonal loan rates (like the kind used to pay off long-standing medical debt) range from about 6% to 36%.

In any of these circumstances, depending on the qualifications of the individual buyer, a cash-out refinance sure seems like the better option to help pay off other loans.

Pros & Cons of a Cash-Out Refi to Consolidate Debt

In the above scenarios, you can see how cash-out refinance will literally help you save a bundle of cash — especially if it’s replacing high-interest debt.

But with that said, there are obvious pros and cons of using a cash-out refi for debt consolidation.

Among the advantages:

  • A cash-out refi used to consolidate debt means fewer monthly payments overall.
  • A cash-out refi means you might pay less in interest, allowing you to pay off the loan more quickly.
  • A cash-out refi will allow you to leverage your home equity when you need it most.
  • A cash-out refi lets you bypass paying taxes on the money you receive because the money is not counted as income.

But cash-out refinancing isn’t a cureall for your financial woes — especially if debt was a big problem to begin with. With a hefty sum of cash in your pocket from a cash-out, it may very well enable the same type of behavior that drove you to debt in the first place. You need a sound strategy to spend the money, or you’ll find yourself caught up in a vicious cycle.

If you don’t believe you can manage the money wisely, how will you deal with other cons of cash-out refinancing? Consider that:

  • A cash-out refi means it will take even longer to pay off your home.
  • A cash-out refi won’t eliminate closing costs. In fact, they may be considerable.
  • A cash-out refi to pay off credit card debt means you’re paying off unsecured debt with secured debt. This type of move is generally ill-advised because your home becomes collateral. That means you risk losing it if you can’t stay out of financial trouble and fail to make payments.

Is a Cash-Out Refi Your Best Option to Consolidate Debt?

There’s only one person who can answer this question for you, and it’s a financial advisor (or lender) you know and trust. This is the person who will be able to scrutinize your finances, double-check the math, look at all the numbers, and tell you if a cash-out refi is the best way to consolidate debt.

Of course, you can also look for your own lenders and compare rates and terms. But no matter what, you’ll want someone who specializes in cash-out refinancing and can answer any questions and concerns you might have.

Before going all-in on the deal, make sure that a cash-out refinance is a smart play as part of a debt-management plan. Understand how it will impact your payments and interest costs over time. If this is really the financial breather you need to squash high-interest debt into a more manageable monthly expense, it should be an informed decision, and one that will require commitment and discipline going forward.


Author: Bryan Dornan

Bryan Dornan is a financial journalist and currently serves as Chief Editor of Cash Out Refi Bryan has worked in the mortgage industry for over 20 years and has a wealth of experience in providing mortgage clients with the highest level of service in the industry. He also writes for RealtyTimes, Patch, Buzzfeed, Medium and other national publications. Find him on Twitter, Muckrack, Linkedin and ActiveRain.

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