In this article
- Are You Wondering Whether Or Not A Cash-Out Refinance Is The Best Way To Pay Off Your Debt?
- What Exactly Is It?
- Some Of The Risks
- - Risking Your Home
- - Closing Costs
- - Credit Score
- Some Alternative Ways To Pay Off Debt
- - Debt Consolidation Loan
- - Balance Transfers
- - Ask For Lower Rates
- - Use The Debt Snowball Method or The Debt Avalanche Method
- Ensure Your Credit Is Right
Are You Wondering Whether Or Not A Cash-Out Refinance Is The Best Way To Pay Off Your Debt?
If you currently have a home that you own, you may be eligible to leverage a cash-out refinance to pay off any current debt you have. There are always pros and cons to these things. You want to consider the pros and cons to figure out whether or not it’s in your best interest to leverage your home’s equity to pay off outstanding debt. You want to look at not only your current financial situation but also your financial goals to figure out if it’s the best decision.
What Exactly Is It?
Doing mortgage refinancing helps you to replace your existing mortgage loan with a completely new one. A lot of people end up doing this type of refinancing to improve the interest rate they are getting and thus decrease their mortgage payments in the process. However, as the principal amount of the loan decreases and your home’s value increases, a cash-out refinance will help you leverage more of the equity you’ve accumulated.
For instance, if you have a $250k mortgage balance on your home that is valued at $400k, a lot of lenders will give you 80% lending power of the current value. Therefore, you could consider refinancing your loan for around $320k.
The total difference between the newest loan you get and the original one is effectively what you receive in cash from the lender. You are then free to utilize that cash for whatever you want including:
– Consolidate any debt
– Make home improvements
– Use as emergency funds
– Use for education
– Deal with other major expenses
However, just because you own property doesn’t mean that you are automatically eligible for it. For one, you need to have enough accumulated equity in your home to meet the requirements of most lenders. For instance, you need to have an 80% ratio of loan to value.
Also, a lot of lenders will end up factoring other things into their lending equation to see whether or not you are eligible. These things can include what your credit score is, whether or not you have existing unpaid debt, your debt to income ratio, what kind of job security you have, and a lot more.
It could be possible to get this type of refinancing without good credit, but it’s not likely. A lot of lenders don’t specialize in working with subprime borrowers and you will likely have a lot of other requirements you need to meet if you want to use this method.
Some Of The Risks
Perhaps one of the main reasons you may want to consider this type of cash-out refinancing has to do with paying off any high-interest debt. A lot of times, you can get a much lower interest rate on your mortgage than any credit card you have. If you have accumulated a lot of high-interest debt, it will make sense to leverage your home’s equity to pay it off so you aren’t stuck paying astronomically high rates.
However, there are major risks to be aware of if you are thinking about using this method. These include:
– Risking Your Home
One of the major risks associated with using this method of refinancing has to do with you using your home as leverage. After all, you are effectively converting unsecured debt into secured debt. With this method, your mortgage payment will increase. If you don’t make timely payments, you are likely to have to deal with foreclosure at some point. Whereas, if you end up defaulting on your credit card payments or a personal loan, it’s not going to have nearly as devastating consequences. While you will have your credit score negatively impacted, it’s not going to cost you the place you live.
– Closing Costs
Any fees that are involved with the refinancing of this type of mortgage loan can add up anywhere from 2 to 6 percent of the total loan. You can usually choose to pay any of these costs upfront or try to roll them into a newer loan. If you do end up paying these costs upfront, you need to have the savings amount to more than the closing costs. If you end up rolling the costs into the loan itself, it’s likely to decrease the total amount you qualify for. Likewise, you would force yourself to have to pay added interest on the added costs from the closing costs for as long as the loan is outstanding.
– Credit Score
Any mortgage lender is going to run a hard inquiry on your reports. Because of this, you are going to find that it decreases your credit score automatically by a few points. Your credit score will also be negatively impacted because anytime you take out a loan, you are going to lower the average age of your accounts and increase your debt to income ratio. Both of these things will lower your total score.
When you are looking at your options, you want to weigh the pros and cons. That way you can figure out if it makes financial sense. You want to do thorough calculations of the numbers to ensure you are making a prudent financial decision.
Some Alternative Ways To Pay Off Debt
If you don’t know if cash refinance is right for you, there are other options you can go with instead. These include:
– Debt Consolidation Loan
This is a loan that you can take out to consolidate your debt and pay off all of the higher interest balances. This process is relatively close to what you get with a cash-refinance loan, but it is usually unsecured. You are taking out a personal loan that doesn’t put your home at risk.
– Balance Transfers
This is a very good option for those that qualify. If you have a lot of credit card debt and a high APR on one of your cards, you can apply for a brand new card that has an introductory 0% APR promotion attached. From there, you can transfer your existing balance to the new card and leverage the promotional period. This can help you eliminate any debt without paying more interest because you get the entire introductory period to pay it off. You will typically have to pay a fee for the transfer, but it’s going to be way less than keeping your debt in an account that’s got high interest.
– Ask For Lower Rates
Believe it or not, you can always ask the lender for lower rates. If you have a good credit score and you’ve always made payments on time, a lot of lenders will lower your rates. You can call them up and make your case for lower rates. This can help you pay off your debts without sky-high rates tacking on more debt.
– Use The Debt Snowball Method or The Debt Avalanche Method
You can leverage various methods to pay off your debts. The debt snowball method has you paying off the minimum balance due for all of your credit cards but focusing more on the ones that have the smallest balance. Once you pay the smallest balance account off, it’s time to go for the next smallest amount. You continue tackling each account until they are all paid off. You can also use another method which is commonly referred to as the debt avalanche method. This one has you targeting your balance that has the highest rate attached. That way, you tackle the ones adding more debt the fastest.
Ensure Your Credit Is Right
No matter what option you intend on going with, you need to ensure you have tabs on your credit. Continually check and monitor your credit reports to ensure the information is accurate. You could have things on your credit report that aren’t accurate which could be lowering your score.
If you don’t have good credit, you need to be proactive about improving it. Try to take various steps to get your credit in a good spot before you apply for a new loan. This can decrease your interest rates substantially. This isn’t an overnight process. It will take some time to improve your credit score. But, when you do, it can save you thousands in interest rates.