Is Refinancing a Viable Option? The Pros and Cons

Should You Be Looking at Refinancing?

For many people, the burdens of debt can become a challenge that is simply insurmountable. But they should take solace in the fact that they are not alone in their struggles. American households are under enormous financial pressure. The household debt has now reached $15.59 trillion (and that was in 2021 according to information from the Federal Reserve). There is a way out for homeowners – and that is refinancing a mortgage to pay non-property-related debt.

The advantage of mortgage debt is that it is usually available at a lower interest rate than other finance options. Accessing the equity of your home can assist you in paying off your debt faster – and save you money. but before you make that decision there are some things that you should know.  

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Can You Access Funds to Pay Off Your Debt?

You need to have built up sufficient equity in your home to access funds – if you have there are a number of options available for those who may have gotten themselves into credit card debt or other forms of debt such as student loan repayments. One option is cash-out refinance. That frees up funds to pay off debt which has high-interest rates. That shifts your debt burden down to mortgage repayments with a lower interest rate. 

Another option is debt consolidation. This approach allows you to combine multiple debts into one. Again, the advantage is that you would then be repaying your debt at a lower interest rate. 

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Cash-out Refinance and Consolidation

The equity in your property can assist you in servicing debt – and save you money.

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Options for Refinancing

There are a number of ways that you can access loans by refinancing your home, or by accessing your home’s equity. These will allow you to pay off your debt faster, freeing up funds. 

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Cash-out Refinance

This option allows you to replace your home loan with an updated, larger loan. If you are approved you will receive the difference between the two amounts in cash (minus various costs). Those funds can then be used to pay off other loans that may have high interest rates (credit cards, medical bills etc). Those debts then become mortgage debts – and only one lower interest monthly payment is required.  

Rate and Term Refinance

This is also known as term refinance. Again your current mortgage is replaced with a new one. That new mortgage will often be over a longer term and have a different interest rate. If you have access to a lower interest rate that will mean lower monthly payments. This frees up the household budget to make other loan repayments on high-interest debt. 

there is also the option of applying for streamline refinance (if you have an FHA or VA loan). It generally is a far easier way of refinancing – there simply is not as much red tape. 

Line of Credit based on Home Equity

A HELOC (home equity line of credit) allows you to borrow against the equity you have in your home. You can access these funds (up to a credit limit) during a period that can be up to ten years. Once this period has elapsed you will no longer be able to draw funds. And then you will have to repay any outstanding balance. This repayment will take place over a set period. The funds that you access in this manner can be used in any way that you see fit. But most financial advisors would recommend paying off higher interest debt.

Is Refinancing to Pay Off Debt a Viable Idea? 

Taking advantage of your home’s equity as a path toward greater financial freedom will depend on your individual financial circumstances. It definitely makes sense if you qualify for that lower interest rate. And that you can absorb the closing costs on the new mortgage. However, if your debt is going to continue to grow it may not be the best option – fiscal discipline is key.  

Let’s take a closer look at the pros and cons of refinancing.

The Pros:

You’ll save money. If you can get a loan with lower interest rates. In fact, you can save thousands of dollars over the medium to long term. That puts cash into your bank account – and that can be sued to pay off other debt. Consolidating debt (with cash-out refinance) has much the same effect. 

You pay off your debt faster. Faster repayments mean that you free up cash for the servicing of other debt. You could use it to save for retirement – or even that sun-drenched vacation that you have always dreamed of taking. 

Great tax benefits. Your payments towards your mortgage (at least the interest) can be tax-deductible. However, the interest you are paying on other debts (like personal loans and credit card debt) may not be. But it’s always advisable to consult a tax professional when it comes to these matters. 

Make your life simpler. We could all do with simplifying our lives. Consolidating your debt by accessing your home equity will mean that you will not be worrying about different repayment dates. The knock-on effect is to make household budgeting that much simpler. And you will not be running the risk of paying those late fees.

The Cons.

It’s not all positive. 

Using your home as collateral for a loan is different from credit card and personal loan debt – those are unsecured. A financial institution cannot seize an asset when/if you default (at least without a court order). However, tapping into your home equity puts that property in the foreclosure firing line if you default. That is the nature of secured debt.  

Cost issues. You will be paying closing cost fees, as well as other fees. Refinancing may not come cheap. Typically those fees are between 2% and 5% of the loan amount. Example: If you take out a $100,000 mortgage you can expect to pay $2,000 to $5,000 for that refinance (according to Freddie Mac). Make sure that you are aware of these costs before making your decision.  

The impact on your credit score. When yu apply for refinancing the lender will perform a hard credit check – and this can have negative effects on your credit score. taking that finance also lowers the average age of your credit accounts – and again that can have negative effects when you apply for other credit. 

It’s not a magic wand. If you have bad spending habits refinancing can add to your problems by freeing up ready cash. Do your budgeting and find out why you got into debt – fix those problems before you consider adding fuel to the fire. 

There are Alternatives.

If you have reservations about taking the refinance path there are other options that are available to repay outstanding debt – consider some of these strategies.

The Debt Snowball. Increase the payments on the smallest debt and maintain minimum payments on others. Once that debt is paid off then you simply move to the next one with the same strategy. The satisfaction of paying off a debt completely can motivate you to keep going.  

Debt Avalanche. Basically the opposite. Make extra payments to your highest debt and simply service the others. you’ll save more on interest payments than the Snowball strategy – but you need to have the money available. It can put enormous pressure on a household budget – but remember, even a few dollars count.  

Debt consolidation. You don’t necessarily have to tap into your home’s equity to enjoy the benefits of debt consolidation. If you have great credit you might very well qualify for a 0% interest credit card. The period of 0% can last up to 18 months (it varies). If you do qualify, transfer your debt to that card account. You will immediately save money. Remember – that transfer may attract a fee, so take that into account. Also, note that once that 0% period elapses you will once again be paying interest.   

Debt relief. There are several non-profit organizations that can assist you when it comes to debt counseling. consider reaching out to one of those. A counselor can help structure a plan for you that will help you to manage your debt. 

Earn more. This is by no means an easy task – but it can be done. consider a part-time job or ways to earn extra income from home. Side hustles are all the rage. 

Personal loans. Step carefully. A personal loan can be a viable option to help pay off high-interest credit card loans (for instance). A personal loan may have a lower interest rate than card debt – but rates vary from financial institution to financial institution. Do your research. And be aware that you’re going to need an excellent credit score to qualify.

So What’s the Bottom Line When it Comes to Refinancing?

Leveraging your home’s equity can help you pay off high-interest loans quickly and with less pain and stress. But remember the drawbacks of a secured loan – default and foreclosure is a very real possibility. 

Your decision must be informed by your unique financial circumstances. It is always a good idea to consult with a financial advisor prior to making your final decision. 

Always take into account that you have many options when it comes to paying off debt. refinancing is one of these, but it only makes sense if you have the discipline to maintain your payments. the money is not free, waste it and you will find yourself in an ever-worsening financial position. If you don’t qualify for refinancing consider some of the other strategies that have been covered (Snowball, Avalanche etc).

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