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Debt Consolidation with Mortgage Refinance: How it Works

Lendstart Updated: June 26, 2023 • 7 min read

What does it mean to consolidate your debt and refinance your mortgage? As debts go, mortgages tend to offer low-interest rates, which is why many consider refinancing their mortgage as a means to pay off other debts they have accumulated. Think about it, instead of having to stay on top of credit card payments, medical bills, student loans or any other form of unsecured debt, you will have one regular payment to keep track of. 

With consolidation, you'll keep your monthly payments lower than what you were paying, with added benefits like the refinanced loan being tax-deductible. It's considered a solid financial strategy to refinance your existing mortgage if you have sufficient equity on your home. Read on to learn how to pay off unsecured debts once your property is appraised and the balance on your mortgage gets deducted.

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What Is Debt Consolidation with a Mortgage Refinance?

Debt consolidation will involve merging several payments into one using a cash-out refinance loan. With money from refinancing, you'll pay off high interest or unsecured loans while saving yourself the hassle of paying multiple bills. The process involves applying for a new mortgage with an amount larger than the total balance owed.

For instance, if your mortgage balance is $200,000, you can refinance your home for $300,000, using the remainder of $100,000 to settle other outstanding debts. The ability to consolidate your debt depends on whether your house has enough equity and if you qualify for another loan. Your new loan shouldn't exceed 80% of your home's value, and your income or credit score determines qualification.

If you borrow more than your house's equity is worth, you'll have to pay for private mortgage insurance or PMI. That's so that your lender can get protected from losses incurred in case of foreclosure. The cash-out refinance loan pays off your existing home loan, and you receive the difference between what's owed and the new borrowed amount.

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Can You Refinance Your Mortgage to Consolidate Debt?

Refinancing your mortgage to pay down debt is a valid option, as it can significantly reduce the interest rate on some of your outstanding debts. Your credit card debt could be charging upwards of 15% interest, and once paid off, you'll remain with mortgage premiums repaid at four or five percent. But that means you're stretching out repayments over a much more extended period, depending on how long it'll have taken you to clear them.

When wondering if you can refinance your mortgage to consolidate debt, remember that you'll need enough equity in your home. If you're an equity-rich homeowner, a cash-out refinance is an attractive option to consolidate your debts. You're required to remain with at least 20% minimum equity after refinancing, and the more you have, the higher the amount of cash you'll receive.

Another factor that lenders consider before approving your refinanced mortgage is the loan to value or LTV ratio of your property. That’s a lending risk assessment, calculated as a percentage by dividing the amount you want to borrow against your home's appraised value. Low ratios, 80% or lower, meaning you have more home equity, are closer to owning it, and are more likely to have refinancing approval.

How to Refinance Your Mortgage and Consolidate Debt

When looking at how to refinance a mortgage and consolidate debt, you could also take out a home equity loan, using the proceeds to clear off other debts. With lower interest rates than personal loans, credit cards, or car notes, the smaller loan on your property lets you pick a repayment period.

Cash-out Refinance

With cash-out refinance loans have the benefit of letting you consolidate your debt at lower interest rates, but you'll repay over a long period. That makes sense if the loans or debts you're paying down are long-term, but not if you'd have taken less time to repay them.

For instance, if you pay off a $10,000 loan at 10% interest over five years, you'll part with $2,748 throughout the loan's lifespan. Using a 30-year refinance mortgage to borrow an extra ten thousand dollars stretches out repayments over another 25 years. You'll end up paying $7,709, even with rates of 4.25%. Besides putting your home at risk of foreclosure should you default on payment, there may also be substantial fees and closing costs for the new mortgage.

Refinancing Rates and Terms

Refinancing your home's mortgage to consolidate debts comes with costs, including application, appraisal, and origination fees. These closing costs can range between 2 and 5 percent of the total loan amount, and you should take care they're not exceeding your interest rate charges. Before you qualify for a mortgage refinance, there are also terms to fulfill, including your credit score, job history, assets, income, and other debts.

A refinance can offer options if you're having trouble making your monthly repayments, but it’s often accomplished without new appraisals or credit background checks. For instance, a 30-year mortgage of $150,000 at an interest rate of 4% would mean your repayments amount to $716 every month. If the loan was for a 15-year term, increasing another fifteen reduces premiums from $1,110, and by reducing the interest to 3%, you'd pay $632 per month.

While the extra cash comes in handy to consolidate other short-term debts, the loan's lifetime means you'll pay higher interest in the long run.

The Impact of Closing Costs and Interest Rates

Before taking a cash-out refinance or tapping into home equity to consolidate high-interest debts, you have considerations to make. It may not be good, especially if your property doesn't meet equity requirements or your financial situation isn't healthy. Above that, your refinanced loan's interest rate and closing costs could mean increasing your house's payments depending on the terms you qualify for.

If you've paid off most of your mortgage's life cycle, extending it another 30 years might be a burden you're not prepared to undertake. You must make rational calculations, or you'll be worse off than before, especially if you run up your credit card or other debts again. Remember that mortgage debt is secured against your home, and refinanced debt consolidation has a high failure rate.

That means that debts previously dischargeable become secured against your equity, and you could face foreclosure if you fail to meet monthly payments. Despite short-term debt clearances, you'll pay more if you don't practice a high level of financial discipline.


Can You Consolidate Credit Card Debt Into Mortgage?

You'll use funds from a cash-out refinance or equity tap to pay off high-interest debts such as credit cards, which should take priority. Consolidation will help you pay off your principal balance if you're swimming in credit card debt.

Factors to consider consolidating credit card debt into mortgage include paying off high-interest cards first if you have multiple providers. Use the lump sum from your refinanced mortgage to clear such a card's principle in what's known as the debt avalanche method. You can then use what you ordinarily pay towards this card to pay the other lower interest cards.

Another tactic is the snowball method, which involves paying off smaller debts first and finishing with high-interest rate cards. You'll watch your debt payoff success snowballing when putting additional funds into the credit card with the highest balance. In essence, it’s vital that you come up with a plan to eliminate suffocating rates which in turn give you confidence to tackle other incremental debt. 

Pros of Mortgage Refinance to Pay off Debts

  • Lowers interest on your outstanding debts
  • It saves money in the long run
  • Pay off debts quicker and covers expenses
  • Improves your credit score
  • Lowers your credit utilization ratio
  • Mortgage interests are tax-deductible
  • You'll lock into lower interest rate for your loan repayments
  • Monthly payments are predictable and manageable 
  • You could end up spending less over the loan’s lifetime

Cons of Refinancing Your Home's Mortgage

  • Your home is used as collateral or security for a new loan
  • Closing costs such as appraisal or origination could eat into savings
  • Monthly payments might increase
  • It could reduce your home's equity
  • A new loan impacts your credit score
  • Savings might be meager and not worth the effort
  • It takes time to refinance your mortgage

Should You Refinance to Pay off Debt?

You must evaluate both the positives and negatives when seeking how to consolidate debt into your mortgage. Mainly, refinancing will depend on your financial situation, high-interest rate debts, your home's equity, and individual goals. While it's a great way to reduce debts, it'll only work if you plan or budget for reduced spending and less uptake of new debt in the long run.

Remember that refinancing may increase your monthly mortgage repayment and reduce overall debt. See our debt consolidation guide for interest rates and closing costs prices you can't ignore. Before settling for a mortgage refinance to pay off high-interest debts, ask yourself; 

  • Is refinancing your mortgage to consolidate debt a good idea?
  • Should you go with a cash-out, rate, and term or equity tap mortgage refinance?
  • Do you require assistance to get your debt or spending under control?
  • How can you make higher than minimum payments to write off your credit card debt?
  • How do you qualify for a refinanced mortgage with your home's high equity?
  • What are the best mortgage refinance lenders and their average closing costs?
  • How much will you get in savings after refinancing your mortgage?
  • Is your loan to value or LTV ratio sufficient for a mortgage refinance?

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