The Pros and Cons of Refinancing for Debt Consolidation

Many Americans have substantial credit card debt, with the national average sitting above $6,000. California only fares a little better than the national average, with an individual average just north of $5,000. While the averages sit around several thousand dollars, it is not uncommon for an individual to accrue north of $10,000 in debt. At these surplus amounts, it becomes apparent to most that debt consolidation is the next likely step. The quickest access to funds and away from crippling double-digit APRs is home equity, but refinancing for debt consolidation might not be the best option for many people.

The Benefits of Consolidating Debt Through Home Refinance

Credit cards typically come with high APR rates; these rates can range from below 14% to 24% or higher. When comparing a credit card APR to a mortgage APR — an average of 3.25% for 30-year fixed or 2.62% for 15-year fixed — it is easy to see why someone would want to consolidate their debt through a refinance.

However, refinancing your home is more challenging and time-consuming than seeking other debt consolidation options. To pursue debt consolidation through refinance, you attempt to take out a new loan against your house, a loan for more than you currently owe. In other words, you are seeking a cash-out refinance.

If approved, your new mortgage would pay off your existing mortgage and leave you with a surplus of funds. The extra money is taken against the equity in your home and can be used as you see fit, paying off debt, for example.

While refinancing sounds like an excellent option because you can eliminate high APRs on various debts, it is wise to take caution before action. Debt consolidation through refinance opens up new challenges and potential risks.

The Cons of Paying Off Debt With Equity

The most apparent risk to using equity to pay off debt is the inevitable increase in your monthly mortgage payment. While you undoubtedly pay similar expenses with all of your debt mixed in, you need to be sure your budget can handle the increase. Beyond the larger home loan leading to larger payments, you need to consider the new loan term. If you are changing from a 30-fixed to a 15-year fixed, the payments can increase quite significantly.

Beyond the monthly price increase, you need to consider the risks of rolling all debt into your home. Currently, if you default on credit card payments, there is no risk to your house. However, by combining all debt into a single mortgage payment, there is now a significant risk to default: your home.

Should You Refinance To Consolidate Debt?

Ultimately, whether you refinance for debt consolidation is your choice. However, there are a few factors to consider before choosing a cash-out refinance. The primary determiner should be your ability to qualify for a better interest rate and terms than your existing mortgage. A secondary consideration is your ability to manage the increase in the mortgage payment without accumulating new debt. Finally, consider the timeline for recovery compared to other consolidation methods.

Are you looking for effective debt consolidation and considering refinancing your home? If so, contact us to discuss your options and situation.