How To Refinance Successfully To Pay Off Your Debt In 3 Steps 

By Alvaro Moreira
9 min read

Are you in debt? You are definitely not alone. Americans on average have personal debt of about $38,000 – home loans excluded. Only 23% of all Americans state that they don’t have any debt. Refinancing your mortgage can make your monthly payments lower and free money up so that you can consolidate your debt. However, is a refinance the right solution for your situation?

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In this article, we will be looking at several different methods for paying off debt and refinancing. We will also be discussing a few reasons why you may want to refinance and will be outlining the next steps you need to take.

refinance

1. Consider Your Debt’s interest Rate

One of the major benefits that are provided by using a refinance for debt consolidation is that the amount of interest you end up paying will be less. One of the more affordable ways that you can borrow money is a mortgage loan. Interest rates are a lot lower compared to student loans, credit card rates, and most other kinds of loans that are available. A refinance makes it possible to pay the high-interest debt off and obtain a lower interest rate as well. 

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Why is Interest Rate So Important?

Let’s look closely at the amount of money that can be saved when your loan is refinanced. Save you have credit card debt of $10,000 as well as a $100,000 mortgage loan. Your mortgage loan has a 3.5% interest rate, while your credit card debt has a 17.78% interest rate. In one month, around $291 in interest is accumulated on your mortgage loan. 

On the other hand, your credit card debt will accumulate interest of around $148. Even though your credit card balance is only 10% of the total amount that is owed on your mortgage loan, you will still be paying half the interest amount of your $100,000 mortgage loan. 

Say you refinance your $10,000 credit card debt into your $100,000 mortgage loan. The new loan will have a $110,000 balance and the same 3.5% interest rate. Now instead of accumulating $148 in interest, the $10,000 will now accumulate only $30 in interest instead. This results in saving over $100 a month by paying the high-interest credit card off and the debt is rolled into your mortgage loan.   

Consolidating also provides you with an easy way to keep up with your payments when you have multiple credit cards with debt. With most kinds of refinances, you only have to make one mortgage payment every month. That will help you avoid missing any due dates and harming your credit score. 

2. Know What Your Refinance Options Are

Your mortgage loan can be refinanced in several different ways, and there are various tricks and tips for refinancing options. Let’s take a closer look at some of the options that are available to take cash out of a loan or reduce your monthly payments. 

Cash-Out Refinances

If you have a large debt that needs to be paid off then you should first consider a cash-out refinance. Before going over what is involved in a cash-out refinance, first, we need to discuss home equity. Each time you make a home loan payment, you will increase the amount of equity that you have on your property. Equity is the percentage of the principal on your mortgage that has been paid off. You own that part of the property.   For example, you may have originally had a $150,000 home loan that has $100,000 remaining on it. In this situation, you have 50,000 in equity on your home. After the final payment is made on your loan, the equity on your property will be 100%. 

How a Cash-Out Refinance Works

When you use a cash-out refinance, home equity is taken out of your house in the form of cash. Your lender, in exchange, will assign a higher principal balance on your loan. Your higher balance, new loan amount then replaces the old loan. You will then continue making payments to the lender just like you did on your old loan.  Say you have a debt of $20,000 to pay off and a principal loan balance of $100,000.  When taking a cash-out refinance you will take out a $120,000 loan. After closing, you will receive $20,000 in cash from the lender. 

How to Apply for a Cash-Out Refinance

The process for a cash-out refinance is very similar to that on the original loan. First, you will apply with the lender, go through the underwriting process, and obtain an appraisal. After all of the paperwork has cleared and the appraisal has been completed, you will sign and close on a new loan. The funds will be wired to you by the lender. Before taking out a cash-out refinancing loan, there are three essential things that you will need to keep in mind.

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To qualify there will need to be enough equity in your home. The maximum that most lenders will allow you to take in cash is 80-90% of the equity in your home. 

Private mortgage insurance may need to be paid for once again. What private mortgage insurance (PMI) refers to is a special kind of coverage that protects the lender in case you default on the loan. When refinancing, if the equity you have is less than 20% then you will be required by the lender to have PMI on the loan. You need to ensure you will be able to afford the additional PMI payment. 

Patiently wait to receive your funds. You will not receive the money immediately after closing. The lender is required to give you 3 days at least after the closing in case you end up wanting to cancel the refinance. That means that the loan does not technically close until this period of time has expired. Most people taking a cash-out refinance will receive their money within 3 to 5 business days after the closing. 

Term And Rate Refinances 

Falling into debt can be easy if you are having difficulties paying your mortgage payments every month. A rate-and-term refinance helps to divert more money towards the debt with the principal mortgage balance changing.  That can help you pay down debt and manage your finances better. A rate-and-term refinance, as suggested by the name, changes your interest rate and/or loan term. When a lower interest rate or a longer-term is taken, the amount you pay every month will be lower. In some rare situations, your term or rate can be refinanced without having to get a new appraisal on the loan.

How A Rate-And-Term Refinance Works 

Say your loan amount is $100,000 with a 15-year term and a 4% interest rate. In this example, your monthly mortgage payment is $739.69. If your loan is refinanced to a 30-year term, then your monthly payment will be $477.42. That will give an extra $262 that can be put towards your debt with more money or PMI being added to your loan. Just keep in mind that if your term is increased that over time you will end up paying more in interest. It is faster to take a rate-and-term refinance than it is to take a cash-out refinance. If you have a VA loan you might be able to get a VA Streamline refinance or if you have an FHA loan an FHA Streamline finance may be available. Streamline refinances have looser requirements and less paperwork. If you don’t qualify to take out a Streamline, the same process can mainly be followed for a cash-out refinance.  

Get an appraisal scheduled and allow your loan to be underwritten by your lender 

Attend a closing meeting to close on the loan. Pay what is owed in closing costs and sign the new loan to complete the process.

Home Equity Line Of Credit

This is not a type of refinance but does allow for the equity in your house to be unlocked and used for paying down debt. HELOCs are not offered by Mor. A HELOC works similar to the way a credit card does. This allows up to 89% of home equity to be accessed to pay debts down. Apply through a local area HELOC provider.  To qualify for a home equity loan or HELOC, usually, you will need to have 18-20% equity in your house at least, a minimum 620 credit score, and around a 40% debt-to-income ratio. 

How A HELOC Works

A HELOC is revolving as well. That means that as the credit is paid off it refills. For example, a $10,000 limit HELOC could be taken out and then spend $7,000. Your line of credit will be $3,000 A draw period will be started by the HELOC. During the draw period, you will be able to spend up to the limit on your loan.  The accumulated interest is the only thing that will need to be paid back every month. Most draw periods are for 5 to 10 years. Once the draw period has closed, you will enter into the repayment period. During repayment, you will not be able to access the line of credit any longer and will need to make monthly payments to pay the loan back. Be aware that those payments will need to be made in addition to the regular mortgage payments every month. Compared to credit cards HELOCs are preferable since they use mortgage interest rates with lower rates compared to credit card rates. A HELOC allows you to access the equity in your home without having to change your original loan’s terms. Another thing you can consider is using a home equity loan to consolidate debt. A lump sum of cash is offered in the form of a second mortgage. At this time, second mortgages are not offered by Mor.   

3. Be Smart About How You Use the Equity in Your Home 

Keep in mind that your home’s ownership percentage is reduced anytime you access the equity. That means that over time you will either be paying more in interest or will have to make more payments on the mortgage before it matures. Your home equity should never be accessed for regular expenses. That can quickly trap you into a cycle of debt. Your home equity should instead be used for one-time, large expenses such as consolidating credit card debt or covering medical bills. Your financial situation should be carefully considered to ensure you will be able to make the new payments before signing a new loan. Then stay current on your payments to avoid getting into debt again. 

The Bottom Line

One of the most affordable ways that money can be borrowed is a home loan. There are two ways this can be done: a cash-out refinance or a HELOC. With a cash-out refinance a higher principal loan replaces the current mortgage and the difference is given to you in cash. Your mortgage rate or term can be refinanced to reduce your monthly payment if you are searching for a long-term solution. You can use a HELOC to access your home equity without your original loan’s terms having to change. Your home equity should only be used for one-time, large payments. HELOS or home equity loans are currently not offered by Moreira Team.

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