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Refinancing to Pay Off Debt

by Violet WillettJanuary 28, 2021
Refinancing to Pay Off Debt

One common money question that arises is, “Should I refinance my home’s mortgage to pay off my debt?” 

As of October 2020, consumer debt in the United States amounted to only a little less than $4.2 trillion according to the Federal Reserve. Troubling financial situations may cause these questions to surface, especially in light of the COVID-19 pandemic when everything seems unstable and uncertain.

Mortgages typically have lower interest rates compared to other types of debt. As Bloomberg reported, US mortgage rates hit a record low of 2.67% for a 30-year fixed loan in December 2020. This was the 15th time rates dropped last year. As such, the prospect of refinancing may be up for consideration.

What does it mean to refinance?

To refinance means to change the terms of your existing mortgage. If you wish to do this, you can go for a cash-out refinance loan. This entails applying for a bigger mortgage that is higher than the current balance you may owe. 

In the process, your existing loan will be paid off and the difference between the new mortgage you take out and your current one can be used to pay off other debts. 

How do you know if you qualify?

It is important to note that cash-out refinance loans have certain requirements. To find out if you qualify, you can work with a broker or get in touch directly with a lender. You will more often than not need to prove that you have 10-20% of equity in your home.

Equity is known as the percentage of your mortgage’s principal which you have already paid. This ensures that you may get a higher principal balance to replace your old one.

Additionally, some lenders will also need evidence that you have paid your existing mortgage for at least a year before your loan can be considered. Higher credit scores will also be scrutinized, and can have a significant impact on your interest rates, as will your debt-to-income ratio which indicates your ability to pay bills. 

In some cases, you might have to get private mortgage insurance which lenders use to protect themselves should you default on your loan. This usually happens if you have 20% equity after you refinance your loan. 

Should you refinance to pay off debt?

Many people opt to refinance their mortgage to pay off their debts to regain a sense of control over their bills. Some may claim that it is more empowering, as they are assured that they have the funds that help them work their way towards having a debt-free status. Refinancing can also be a strategic decision if your existing mortgage has higher than average interest rates.

It is also advised mostly for individuals who intend to remain in their current home in the long-term, as it gives them the opportunity to pay off closing costs. These fees can be anywhere between 2-6% of your loan’s amount.

Refinancing is not for everyone. The decision to refinance your mortgage is one that requires a careful assessment of your financial situation and habits. 

There are also inherent risks in the process. You could be putting your property in a precarious situation if you pay off your other personal debts with your mortgage, as you are turning unsecured debts into secured ones. Failing to make payments can result in defaulting on your loan or even in foreclosure.

Think refinancing is for you? Take a step back and weigh out its pros and cons. Everyone’s financial health and situation is different. Think in the long-term, shop around for options, and speak to a broker if you want to see how suitable refinancing is for you. 

If you want to learn more about mortgage rates and how the pandemic has caused them to fluctuate, you can have a look at our article on ‘4 Reasons Why Coronavirus Makes Mortgage Rates So Unpredictable.’

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