5 Benefits of Refinancing Your Home Loan to Consolidate Debt

Being in debt can be stressful for anybody, regardless of the type of debt and how high it is. Unless you have enough money set aside to pay for everything, the chances are good you’re carrying at least some debt and are wondering the best way to eliminate it.

At Addition Financial, we often talk to our members about debt and how to manage it, including details about debt repayment strategies. Homeowners ask about refinancing to consolidate debt and that’s something that may be worth considering. With that in mind, here are five benefits of refinancing your existing home loan to consolidate debt.

When does consolidating debt make sense?

If you’re handling your existing debt with minimal stress, then consolidating debt may not be the right solution for you. However, if you have experienced one or more of the following things, then it could be a sign that debt consolidation is the best way to reduce stress and get out of debt as quickly as possible:

  • You’re paying high interest rates. A lot of credit cards, and some loans, come with high interest rates that can add thousands of dollars to your repayment over time. If you’ve got debt with high interest rates, then consolidation can help you save money every month.
  • You’re making multiple monthly debt payments. Maybe you’re paying several credit cards, a student loan and a car loan every month. Keeping track of multiple debts can make it more challenging to stay on top of it, so consolidation provides a way to make a single monthly payment.
  • Your credit score has improved. If your credit score has significantly improved since you applied for your credit cards or loans, then it’s likely you’ll be able to qualify for a lower interest rate than you had initially and save money as you repay your debt.
  • You’re committed to getting (and staying) out of debt. Debt consolidation only makes sense if you use the money to get out of debt and stay that way. If you pay down your debt and run it back up again, you’ll have paid for a loan that left you no better off than you were to begin with.

If you’ve experienced any of these things, then it may be a good idea to consider debt consolidation as a way to pay down your debt and improve your financial situation.

What are some good reasons to refinance your mortgage?

Now, let’s look at some of the reasons why refinancing your mortgage is a good idea. You won’t do yourself any good if your refinancing puts you in a financially precarious position, so here are some of the signs that refinancing could be a good idea:

  • You have at least 20% equity in your home. The first requirement is equity, since that’s what your refinancing lender will use as collateral for your debt consolidation loan. Most lenders require a minimum of 20% equity for cash-out refinancing.
  • Interest rates are low. Most American homeowners have a 30-year fixed mortgage, which means they lock in their interest rates when they sign their mortgages. If current rates are lower than your existing rates, then refinancing may make sense.
  • Your monthly debt payments are too high. Monthly debt payments can be stressful to make and if you’re feeling the pinch, refinancing your mortgage could help to lower your payment and potentially give you the money to pay down your debt.
  • You want to get rid of mortgage insurance. People who buy homes through the FHA are required to pay for mortgage insurance for the term of their home loan. Refinancing can help you eliminate mortgage insurance and reduce your monthly payment. Keep in mind that this only applies if will have enough equity to avoid mortgage insurance after refinancing.

If debt refinancing makes sense for you based on the criteria above, then it may make sense to use your home equity to consolidate and pay down your debt. You can use our free calculator to determine whether you can save money with refinancing.

How does refinancing a mortgage to consolidate debt work?

Now let’s talk about how refinancing a home loan to consolidate debt works. Home refinancing can be a simple process that involves lowering your interest rate and monthly payments without using the equity in your home. However, debt consolidation requires cash-out refinancing to get the money to pay your debts.

The process of refinancing to consolidate debt has a couple of important differences from typical refinancing. Here are the usual steps you would follow to refinance:

  1. Gather documentation, including 30 days of paystubs, asset statements, and tax returns if you are self-employed or have income from sources other than employment.
  2. Research lenders to find those with the most favorable terms.
  3. Complete your mortgage refinancing application.
  4. Get your decision.
  5. If approved, attend the closing and reap the benefits of a lower monthly debt payment.

The first thing that’s different with a debt consolidation refinance is that you will need to calculate your home equity before you apply to make sure you have enough equity to qualify for a cash-out refinance and that the equity you have will be sufficient to pay your debts.

The second difference is that you will receive money at your closing, typically as an electronic transfer, that you will use to pay off your debts. If you don’t receive enough funds to pay everything, you may want to pay the balances with the highest interest rates first and work your way down from there.

5 benefits of using a cash-out refinance to consolidate debt.

There are many benefits of refinancing a home loan to consolidate debt. Here are five to consider.

#1: You’ll have a lower monthly payment.

Refinancing your home loan can help reduce your monthly mortgage payment and remove some of the financial pressure you may be feeling. As we noted above, it only makes sense to refinance to consolidate debt if you can qualify for a lower interest rate.

Not only can your lower monthly payment remove monthly stress, it can also lead to paying significantly less in interest over the term of your loan. 

#2: You’ll save money on debt repayments.

When you use the cash from your home equity to pay off your debts, you’ll save money on those payments as well. Many credit cards come with high interest rates that can add up over time, and paying the reduced interest on your refinanced mortgage can help you save.

You’ll be making a monthly payment that will be lower, too, which means you’ll have more money to use for other expenses or to build up an emergency fund.

#3: You’ll have only one payment to make each month.

We already mentioned that making multiple debt payments each month can be stressful and time-consuming. You may feel that you need to juggle payments, particularly if they all come due at around the same time each month.

When you use refinancing to consolidate debt, you’ll eliminate those multiple payments and make just one payment (assuming you get enough money from your refinancing to pay off all your debt.) That means you’ll make one payment each month and won’t have to worry about having enough money to pay everything.

#4: You may improve your credit score by paying down debt.

One benefit of paying down debt that doesn’t get enough attention is the possibility of improving your credit score. Refinancing gives you the option to pay all your debt at once, thus eliminating the possibility of late payments.

On a related note, your debt utilization plays a significant role in determining your FICO score. When you pay down debt, you may also reduce your total debt, particularly if you qualify for a lower interest rate. With a lower amount outstanding, you may see a rapid improvement in your credit score.

#5: Paying down debt reduces financial stress.

There’s no denying that carrying a lot of debt — and juggling funds to repay it — can take a toll on people, causing intense stress and anxiety about money. There’s plenty of evidence to suggest that stress can contribute to health issues such as depression and even heart disease.

People who have a lot of debt can reduce their stress by refinancing a home loan to consolidate their debt with lower monthly payments.

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Potential risks of refinancing to consolidate debt.

It is important to keep in mind that you’ll be responsible for closing costs for your new loan, so make sure to calculate those and take them into account before you refinance.

You should be aware that you’ll be using your home and home equity as collateral, so making your monthly payments on time is essential to avoid foreclosure. In many cases, you will have a single monthly payment that will be lower than what you were paying prior to refinancing.

If you are juggling multiple debt repayments every month and worried that high interest rates will affect your financial status for the foreseeable future, refinancing your home loan to consolidate your debts might be the right choice for you. The 5 benefits of refinancing to consolidate debt we’ve listed here can help you make that decision.

Are you considering a debt consolidation loan to reduce your monthly payments and save money? Addition Financial can help! Click here to read about our mortgage refinancing options and start the application process today.

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