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Bargain Haunting? Refinance to Create Breathing Room in Your Budget

Timm Ready, CMA,  Sr. Mortgage Advisor

October 9, 2023 — 10 min read

Refinance to Create Breathing Room In Your Budget

It’s often said that talk is cheap—unless, of course, you’re talking about today’s interest rates.

While the numbers of the day are relatively low compared to rates over the last 50 years, the cumulative effect of debt can add up quickly to derail your long-term financial goals.

That’s where a refinance to consolidate debt comes in—even if you have a low rate on your mortgage, do you know how much you’re paying in interest each month for your credit cards and vehicles?

With inflation and interest rates rising every month for over a year now, more people are falling behind on their auto and credit card payments than at any other point in more than a decade, according to experts.

For countless borrowers, it boils down to simple math: refinancing to consolidate high-interest debt can lead to more breathing room and substantial savings in the long run. Below, we explore options to refinance and consolidate debt to secure a strong financial future.

Should I Refinance My Mortgage to Consolidate Debt?

You can consolidate debt in a mortgage refinance and point the home equity cash toward credit card or other debts. However, like everything else, it’s important to thoughtfully examine your long-term financial goals, current debt obligations, and your overall financial health before moving forward.

How does debt consolidation work?

Debt consolidation through a refinance is most effective when the equity in your home permits you to pay off a significant portion, if not the entire balance, of high-interest debt. In short, here’s how it works:

  • It consolidates all your debts into a single, manageable payment
  • It could lower the interest rates you’re paying on each individual loan or shorten your term, helping you clear your debts faster
  • Paying off debts on time or faster can improve your credit score

To be eligible for home refinancing, you must have a consistent record of on-time mortgage payments; this history can positively impact your credit rating, making you a more attractive candidate for refinancing.

LEARN MORE: Too Much Summer Spending? How to Consolidate Debt

Refinance to Create Breathing Room In Your Budget

Do I have enough equity to refinance?

It's important to strike a balance between the amount you borrow and the equity you retain in your property. The equity you leave in your home post-refinance carries significant importance, as it directly impacts your loan-to-value (LTV) ratio; the LTV ratio plays a crucial role in determining whether you'll need to obtain private mortgage insurance (PMI), an additional expense that can substantially increase your monthly mortgage payment.

RELATED: How to Remove PMI: Everything You Need to Know

For example, if your loan amount is $300,000 and your home is appraised at a value of $400,000, then your LTV is 75 percent.

LEARN MORE: What's an LTV Ratio? Everything You Need to Know

Before committing to a mortgage refinance, it's good idea to perform a thorough cost-benefit analysis. Calculate the total cost of the refinance, including closing costs, and compare it to the potential savings from consolidating high-interest debt. Consider how the new mortgage terms will impact your monthly budget and whether the long-term interest savings outweigh the upfront expenses.

Your creditworthiness plays a significant role in securing favorable refinancing terms. Obtain a copy of your credit report, assess your credit score, and identify any inaccuracies and work to rectify them, if necessary.

RELATED: How to Fix Errors on Your Credit Report

In general, a higher credit score can translate into lower interest rates, potentially enhancing the benefits of debt consolidation through refinancing.

Want Help? Click here to connect with a neighborhood Mortgage Advisor today.

Factoring in closing costs

Before you commit to refinancing as a means to consolidate your debts, it's crucial to understand how closing costs play into your decision. Most lenders charge fees that can amount to a significant sum when you refinance your mortgage. This is money that could potentially go towards paying down your existing debts. To determine if refinancing is financially beneficial, you must weigh these closing costs against the overall interest savings you stand to gain from consolidating your debts.

Benefits of Refinancing to Consolidate Debt

With this information top of mind, refinancing to consolidate debt offers a range of compelling benefits, including:

Streamlined debt management. One of the primary advantages of debt consolidation through refinancing is achieving a much simpler financial life. Instead of dealing with multiple high-interest debts from various sources, you consolidate them into a single, more manageable payment. This consolidation streamlines your finances, reduces the complexity of tracking multiple due dates and payment amounts, and provides you with a clearer picture of your overall finances.

Enhanced monthly cash flow. Consolidating high-interest debts through refinancing can lead to immediate financial relief. It can help provide more breathing room in your budget, making it easier to manage finances effectively and potentially improve your overall financial stability.

Positive impact on credit score. Timely and consistent payments on your consolidated debt can positively impact your credit score over time. As you pay down your debt and maintain good credit habits, your creditworthiness may improve; this can open doors to better financial opportunities in the future, including access to lower interest rates on future debts.

RELATED: How to Build a Good Credit Score and Maintain It

Potentially lower interest rate. High-interest debt can be a significant financial burden, with interest payments adding up over time; by refinancing and potentially obtaining a lower interest rate, you can save a substantial amount of money on interest payments over the life of your consolidated debt.

Refinance to Create Breathing Room In Your Budget

Potential tax benefits. In certain cases, the interest paid on mortgage debt may be tax-deductible, while interest on credit cards or personal loans typically is not. When you consolidate your debt through a mortgage refinance, you may gain access to potential tax deductions, reducing your overall tax liability. Consult with a tax professional for additional details.

RELATED: What Are the Tax Benefits of Owning a Home?

Long-term financial strategy. Debt consolidation through refinancing is not just a short-term fix; it can be a crucial component of your long-term financial strategy. By eliminating high-interest debt and creating a structured plan for repayment, you set yourself on a path toward financial stability and security. It enables you to regain control of your finances, reduce financial stress, and work towards achieving your broader financial goals.

Mortgage Refinance Options

Rate-and-Term Refinance

Rate-and-term refinancing, often referred to as a "no cash-out" refinance, focuses on adjusting the interest rate and/or the loan term of your existing mortgage. This type of refinance does not allow you to access additional funds.

What’s the benefit?

Rate-and-term refinancing can help you secure a lower interest rate, potentially reducing your monthly mortgage payments. It's also a valuable option if you want to change the duration of your loan; for example, you can switch from a 30-year to a 15-year mortgage to pay off your loan faster and save on interest over the life of the loan.

Cash-out refinancing allows you to borrow more than your current mortgage balance and receive the excess funds in cash; this money can be used for various purposes, such as debt consolidation, home improvements, or investment.

RELATED: Love Your Home? Skip the Chocolate—Speak Your Heart with a Cash-Out Refinance

What’s the benefit?

Cash-out refinancing provides access to a lump sum of cash, making it an extremely versatile option. Common uses include consolidating high-interest debts, funding home renovations that can increase your home's value, or investing in opportunities with a potentially higher return than your mortgage interest rate.

Student Loan Cash-Out Refinance

This specialized form of cash-out refinance is designed for borrowers looking to use home equity to pay off high-interest student loans. It allows you to consolidate student loan debt into your mortgage, potentially securing a lower interest rate.

What’s the benefit?

Student loan cash-out refinancing can significantly lower your student loan interest rate and simplify your monthly payments by combining them with your mortgage. It's an excellent choice if you have substantial student loan debt and want to reduce your overall interest payments.

FHA Refinance

The FHA Refinance is made for homeowners with existing FHA loans; it offers a lower rate, home equity access, and it reduces the UFMIP amount. It's ideal for borrowers looking to lower payments or tap into home equity, and for those wanting to build their credit score.

What’s the benefit?

FHA refinancing requires less paperwork and has less stringent credit and income requirements compared to other refinancing options. It's an attractive choice for FHA borrowers seeking to lower their monthly payments and interest rates.

VA Streamline (IRRRL) Refinance

The Interest Rate Reduction Refinance Loan (IRRRL), commonly known as the VA Streamline, is exclusively available to eligible veterans, service members, and surviving spouses with existing VA loans. It aims to reduce the interest rate on the current VA loan.

What’s the benefit?

VA Streamline Refinances are known for their straightforward process and minimal documentation requirements. They offer veterans an efficient way to lower their mortgage interest rates and monthly payments without extensive paperwork or financial burden.

Other Options

Second Mortgage (Home Equity Loan or Home Equity Line of Credit)

Second mortgages, also known as a home equity loan or home equity line of credit (HELOC), are another option for homeowners looking to access their home’s equity. Unlike a refinance, a second mortgage doesn't replace your existing mortgage; instead, it allows you to borrow against the equity you've built up in your home.

What’s the benefit?

Access to home equity. With a second mortgage, you can tap into the equity you've accumulated in your home, typically up to a certain percentage of your home's appraised value, minus your existing mortgage balance.

Flexible use of funds. The funds obtained through a second mortgage can be used for various purposes, such as home improvements, debt consolidation, educational expenses, or other financial goals.

Structured repayment. Second mortgages come with structured repayment plans, often offering fixed monthly payments for home equity loans and flexible borrowing and repayment options for HELOCs.

Preservation of current mortgage terms. A second mortgage allows you to keep your existing mortgage terms intact, which can be beneficial if you have a low-interest rate on your primary mortgage that you want to maintain.

HELOC interest is tax deductible only if the borrowed funds are used to buy, build, or substantially improve the taxpayer’s home; it's important to speak with a professional tax advisor before applying for a HELOC or a Home Equity Loan.

Refinance to Create Breathing Room In Your Budget

It's important to note that a second mortgage carries its own set of terms and costs, including interest rates and closing fees. Additionally, it creates a secondary lien on your home, so it's crucial to manage the repayments responsibly to avoid the risk of foreclosure.

Click here to connect with a neighborhood Mortgage Advisor today.

Personal loans

By opting for a personal loan, you avoid the risk of losing your home as collateral, which is a factor to consider carefully. However, while personal loans offer security, borrowers should be prepared for potentially higher interest rates compared to mortgage loans. Weigh the benefits of safeguarding your home against the cost of the loan to determine if it aligns with your financial priorities.

Debt management plans

Credit counseling agencies provide programs designed to assist individuals in consolidating unsecured debts. These programs typically involve initial setup fees and may require additional time for approval, as negotiations with creditors are necessary to determine acceptable payment terms. If you don’t meet the eligibility criteria for a debt consolidation mortgage, a debt management plan could be an alternative worth considering.

Next Steps Towards a Strong Financial Future

Take a deep breath in, then a deep breath out—just by reading this blog, you’ve taken the first step towards giving your budget and long-term financial goals more breathing room. Reach out to your neighborhood Mortgage Advisor today to take a confident next step towards a strong financial future, or click here for a personalized quote.

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