Debt consolidation refinancing is a popular option for some homeowners—and that’s because it simplifies bill paying, can reduce the amount of money going toward debt service each month, and allows for more financial freedom.
Homeowners may wonder, “Is a home refinance to consolidate debt the right option for me?” If you’re considering refinancing, the Experts are here to help you understand the intricacies of a debt consolidation loan so you can make the choice that’s best for you.
Lower Your Rate
Reducing your interest rate can save you a lot of money in the long term while also lowering your monthly payment.
Shorten Your Loan Term
Shortening your loan term allows you to speed up the rate at which you build equity. That means saying goodbye to years of payments!
Lower Monthly Payments
Who doesn’t want a lower monthly payment? Lowering your payment can save you thousands over the life of your loan.
What Is a Debt Consolidation Refinance?
Debt consolidation loans (a.k.a. cash-out refinance) are loans that replace your existing mortgage with a brand-new home loan for more than what you owe on your house—and the difference is paid to you in cash. Put simply, you can get cash and get a new mortgage at the same time, while also combining your debts.
During debt consolidation loans, homeowners pull from their built-in home equity and consolidate other high-interest debts by rolling them into a brand-new mortgage. This means your credit card balances and other loans can get bundled into the new mortgage amount—creating a single monthly payment for all your debts. During the closing of a debt consolidation refinance, your credit cards and non-mortgage loans get paid off. This results in a higher mortgage balance, and the non-mortgage debts get absorbed into the new loan.
When Is Debt Consolidation Advisable?
Debt consolidation is recommended for homeowners who have a good deal of equity in their homes that can be tapped to pay off other high-interest debts (such as credit cards, car loans, or personal loans). Since the goal is to refinance into a low-interest mortgage, borrowers with a high credit score are in the best position to take advantage of this refinance type.
In addition to credit scores, lenders will evaluate homeowners based on their income and debt-to-income ratios. Borrowers must also be at least 18 years old, legal U.S. residents with a verifiable bank account, and not be in bankruptcy or foreclosure.
Why Do a Consolidation Refinance?
Now that you know how these loans work, you’re probably wondering: is this the right loan for me? There are three essential questions homeowners should ask themselves when considering a debt consolidation refinance:
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Will I lower my interest rates?
The main reason homeowners tend to choose a debt consolidation mortgage is to move from having high-interest, unsecured debt to having low-interest, secured debt. For example, credit card interest rates typically range from 10% to 25%, based on the principal amount owed. Mortgage loans, however, have competitively lower interest rates, hovering around 2% to 5%. So, choosing the right debt consolidation loan is largely determined by which loan offers the lowest annual percentage rate.
Having non-mortgage debt rolled into a mortgage allows borrowers to pay a way lower interest rate. However, because mortgages have significantly longer repayment terms than most personal loans, homeowners should be prepared to pay more aggressively on their refinanced mortgage to avoid overpaying on the consolidated debt.
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Will I lower my payments?
At the same time, a consolidation loan offers more month-to-month flexibility since, while the mortgage balance may go up, borrowers are not also making additional monthly payments to debt with higher interest rates. They may pay whatever they can above their mortgage payment, but they don’t have to. That means if they run into problems one month — like the need to pay for expensive car repairs — they have the extra cash on hand to do so.
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Will this help my credit?
Unsecured debts are loans that are not backed by collateral; they include credit cards and medical bills. These debts are considered higher risk to lenders, which leads to higher interest rates (to offset the risk that consumers might default on their repayment obligations). Additionally, if you have a lot of credit card debt and you default on it, the lenders can take you to court and seize your assets to satisfy the debt you owe—an outcome you definitely want to avoid!
So when non-mortgage debt gets rolled into a mortgage loan, the unsecured debt gets paid off and it becomes part of the secured mortgage. That means that if a homeowner decided to sell that property, the debt would disappear upon closing, when the mortgage balance gets paid off by the purchase cash.
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What Are the Requirements for Debt Consolidation?
Lastly, there are several requirements borrowers will want to keep in mind when considering a debt consolidation refinance program:
- That monthly debt payments (including rent or mortgage) don’t exceed 50% of a homeowner’s monthly gross income.
- That the homeowner’s credit score is good enough to qualify for a 0% credit card or low-interest debt consolidation loan.
- That the homeowner’s cash flow consistently covers payments toward debt.
- That the homeowner can pay off a consolidation loan within five years.
What Steps Are Involved in a Debt Consolidation Refinance?
There are certain steps you should take to make the debt consolidation process go as smoothly as possible.
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1. Figure out how much is owed.
First, it’s crucial to add up your debts. This will help you determine exactly how much to borrow if you choose to consolidate with a home refinance loan. Also, keep in mind that debt consolidation loans can’t be applied to student loan debt—consolidation for federally-guaranteed student loans only happens within the U.S. Department of Education.
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2. Calculate the average interest rate.
Your credit cards may have different interest rates and balances, so the number borrowers are really looking for is the weighted average interest rate. Find an online calculator and let it do the math for you. Your average credit card interest rate will give the lender a number to beat.
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3. Determine an affordable monthly payment.
Next, consider how much you can comfortably pay for a monthly mortgage payment (after accounting for your other monthly expenses). Be sure to account for necessities like food, housing, utilities, and transportation.
After adding up your expenses, determine what money you’ll have left that can be used to pay extra on your mortgage—you want to ensure that the credit card debt is covered swiftly.
A monthly consolidation payment must fit the prescribed budget you’ve laid out. A good rule of thumb is that all homeowners should follow the 50/30/20 rule, which divides income into three categories: needs (50%), wants (30%), and savings and debt repayment (20%).
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4. Order a credit report.
Great news: you can get a credit report free of charge. This report will list all your debts—including some that may have been forgotten in your initial calculations. A credit report will help you determine if your debt-to-income ratio will be good enough to qualify you for a sufficiently low interest rate.
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5. Check your credit score.
Your credit report will also contain your credit score. This number will help you determine if you actually qualify for a debt consolidation refinance. A credit score of 650–690 or higher on the FICO® scale is typically sufficient to qualify. You may be able to qualify with a lower score, depending on your lender’s requirements. However, you can expect higher interest rates if your score is lower, since lenders use credit scores to determine how much of a risk you represent.
How Can The Home Loan Expert Help?
We come from humble beginnings, and started our company 20 years ago by going door-to-door and helping our neighbors find the best home loan refinancing opportunities. Our company has grown in so many ways, but we still provide amazing refinancing services with a personal touch, offered by highly qualified Experts from the very communities they’re serving.
We specialize in meeting each client’s unique refinancing needs, and we fully understand that everyone’s mortgage situation is different. Our team of friendly, professional lending Experts are ready for your call to determine if a debt consolidation refinance is right for you.
Learn About Other Loan Types
Rate-and-Term Refinance
A rate-and-term refinance, also known as a no cash-out refinance, allows you to change your mortgage’s interest rate and loan terms without changing the principal balance. Basically, it’s a loan improvement—you’ll be trading your current mortgage for a better one. With a rate-and-term refinance, The Home Loan Expert team can help homeowners who are looking to pay off their house early, and are a great way to take advantage of lower mortgage rates. Here, we’ll take a look at why this refinancing option can be a smart choice for eligible homeowners.
Refinance
Refinancing your home loan can be a smart financial move, whether you’re looking to lower your monthly payments, shorten your loan term, or tap into your home’s equity. At The Home Loan Expert, we offer a variety of refinance loan options tailored to help you achieve your financial goals.
Cash Out Refinance
Have you been wanting to make repairs or renovations to your home, but had difficulty finding the funds? Fortunately, there are great options available that don’t involve taking out additional mortgages, personal loans, or credit cards. A cash-out refinance, for instance, helps homeowners access the funds they’ve already paid into their home loan to cover major upgrades, serious renovations, or even a dream vacation. If you’re considering a cash-out refinance, The Home Loan Expert can help you determine if it’s the best option for you and walk you through the entire process.
