Refinancing your home to pay off other debt could help you consolidate your balances and possibly save on interest. But it comes with substantial risks, and it may not be your best option if you donât qualify for a lower interest rate, or if youâd struggle making your new payments.
If youre carrying substantial debt, it may be difficult to pay off your balances without taking some significant action. Refinancing your home to pay off your debt is one option, but its a move that comes with significant benefits and potential downsides that should be considered beforehand.
Generally, refinancing your house to pay down debts might not be a good idea if youll struggle to afford your new payments or youre unable to get a better rate on your mortgage.
Refinancing a mortgage can be a smart financial move for homeowners looking to lower their interest rate or monthly payment. But if you have existing credit card debt you may be wondering if you should pay that off first before refinancing your home loan. Paying off credit cards prior to refinancing can impact your interest rate loan eligibility and long-term savings. Here’s what you need to know about paying off credit card debt before refinancing your mortgage.
How Paying Off Credit Cards Can Affect Mortgage Refinancing
There are a few key ways that paying off credit card balances prior to refinancing can impact the process:
Interest Rates
Lenders review your credit history, scores and debt-to-income ratio when determining your mortgage refinance rate The higher these numbers, the higher your interest rate is likely to be Paying off credit card balances lowers your debt-to-income ratio and can improve your credit scores. This may allow you to qualify for lower mortgage rates when you refinance.
Loan Eligibility
High credit card balances can negatively impact your debt-to-income ratio, which lenders review to determine if you qualify for a refinance. Paying down balances strengthens your ratio and can help you meet eligibility requirements for a new home loan.
Long-Term Interest Savings
Since mortgages have lower interest rates than credit cards, consolidating your high-interest credit card debt into your home loan can lead to substantial interest savings over the life of your mortgage. However, you may miss out on some of these savings if you refinance before paying off cards.
When To Pay Off Credit Card Debt Before Refinancing
As a general rule, it’s smart to pay down as much credit card debt as possible prior to refinancing. However, every situation is different. Here are some guidelines on when you should pay off credit cards first:
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You’re carrying high balances: If you have credit card balances that are 50% or more of your total available credit, pay them down before refinancing. This will significantly help strengthen your credit profile.
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You can pay cards off completely: If possible, try to pay off credit card balances in full so you can realize the maximum interest savings when consolidating the debt into your mortgage.
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Your credit score needs a boost: Paying off cards can improve your credit score, sometimes substantially. If your score needs a bump to get approved for refinancing, pay down balances first.
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You’re consolidating debt: If your goal is to consolidate credit card debt into your mortgage to save on interest, pay off as much as you can first to maximize savings.
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You’re struggling with payments If high credit card payments are stretching your budget pay down balances before taking on a new mortgage payment.
When Refinancing First May Make Sense
In some cases, it may be advantageous to refinance your mortgage before tackling credit card debt:
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Interest rates are spiking: If rates are rising, lock in your refinance rate quickly before they go up further. You can then pay off debt.
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Your credit is already strong: If your credit score and debt-to-income ratio are already in great shape, refinancing first won’t hurt you.
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You need cash urgently: A cash-out refinance can give you access to funds immediately to pay off cards.
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You can’t pay off cards completely: If you can only make a small dent in your credit card debt, it may be better to refinance first.
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The mortgage savings are significant: If you’ll realize substantial monthly mortgage savings from a refinance, use those funds after refinancing to pay off cards.
Using a Cash-Out Refinance to Pay Off Credit Card Debt
A cash-out mortgage refinance allows you to take equity out of your home in cash, which can then be used to pay off credit card debt. This lets you consolidate high-interest credit cards into your lower-rate mortgage. However, cash-out refinancing also increases your mortgage balance and decreases your equity. Make sure you can still comfortably afford the higher monthly payment before using this method.
Tips for Managing Credit Card Debt During Refinancing
When juggling credit card debt and mortgage refinancing, here are some tips:
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Prioritize paying off cards with the highest interest rates first.
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Avoid racking up new card balances before refinancing.
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Be conservative when taking equity out through a cash-out refinance.
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Have a plan for paying off any remaining card debt quickly.
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Consider balance transfer cards to consolidate debt at a lower rate.
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Use mortgage savings to accelerate credit card debt repayment after refinancing.
Consult a Financial Advisor
Deciding when to pay off credit card debt and refinance can be a complex decision. Speaking with a financial advisor can help you evaluate your full financial picture and determine the best timing and approach for your unique situation. They can run the numbers and ensure you maximize both mortgage and credit card savings over the long term.
Refinancing and paying off credit card debt takes careful planning. In many cases, it is smart to pay down balances first before refinancing to improve your credit standing and interest savings. However, it’s important to weigh many factors like your equity, savings goals and current finances. With strategic timing, you can take advantage of your home loan to help conquer high-interest credit card debt.
How to Decide Whether to Refinance
Refinancing can have serious implications on your finances, so you should proceed carefully before deciding whether to refinance to pay down debt. The most critical detail to consider is the current interest rates on your mortgage and other debts and the new mortgage rate youll receive if you refinance. After all, it makes little sense to refinance if youll end up with a considerably higher interest rate.
Here are some factors to weigh as you make your decision:
- Your interest rate: If you qualify for a rate at least 1% lower than your current mortgage rate, a rate-and-term refinance may make sense. However, a minimal rate drop of less than 1% may be too negligible to make a meaningful difference, especially when you factor in closing costs.
- Your current debt level: Refinancing could be worth it if your existing debt and interest rate are so high that the balance is increasing significantly due to interest charges. Conversely, a refinance may not be your best option if your debt level is relatively lowâsay, a few thousand dollars or less. In that case, following a debt repayment strategy may suffice to tackle your debt.
- Your monthly budget: A cash-out refinance can help you pay off high-interest debt, but it may leave you with a higher mortgage payment. Project your budget post-refinance to ensure you can afford the larger payment, taking into account the debt accounts you plan to settle.
- Refinance closing costs: Closing costs can range from 2% to 5% of a new mortgage loan. These closing costs usually represent thousands of dollars in upfront expenses. Since it takes time to recoup closing costs, refinancing may not be worth it if you plan on moving soon.
- Likelihood you will accrue new debt: Refinancing to pay off your debt isnt a great idea unless you have a plan in place to avoid new debt from building up in the future. Having zeroed-out credit cards can increase the temptation to spend, and it can take some serious planning to avoid ending up right back where you started.
How Can Refinancing Help You Pay Down Debts?
The primary benefit of refinancing your mortgage to pay down debt is saving money in interest: Mortgage rates are generally lower than other types of consumer credit like credit cards and personal loans.
For example, the average interest rate on 30-year fixed-rate mortgages was 6.39% in early May. By contrast, the latest Federal Reserve data lists average interest rates of 20.92% for credit cards and 11.48% for 24-month personal loans. With Americans carrying an average credit card and personal loan balance of $5,910 and $18,255, respectively, according to Experian data, its plain to see how high interest rates on these balances can add up.
You can refinance your home to pay down debt in one of two ways:
- Rate-and-term refinance: A rate-and-term refinance involves replacing your current loan with a new one that, ideally, carries a lower interest rate. The new loan may also introduce a new repayment term and monthly payment amount, but the principal balance remains the same. A lower payment can provide you with extra cash you can use to pay down debt.
- Cash-out refinance: A cash-out refinance also works by replacing your current mortgage with a new one, but in this case, the refinance loan is larger than the remaining balance on your mortgage. You can use the difference to pay off debts, fund a home renovation project or for virtually any legal purpose. One important distinction is that the larger loan balance usually raises the overall cost of your loan, even if you secure a lower rate.
In summary: When interest rates are low, a rate-and-term refinance can free up room in your budget to make higher debt payments without adding more principal debt to your mortgage. By comparison, a cash-out refinance provides you with a lump sum of cash to pay off debts, but can increase your monthly payments.
Using a cash-out refinance for paying off debt
FAQ
Is it worth refinancing to pay off credit cards?
Refinancing your credit card debt may be just the ticket to strengthen your financial situation, or it may not be the best option for you. It all depends on your financial situation. If you’re on solid financial footing, but don’t want to keep throwing money at high interest rates, go for it.
Should I pay off credit cards before getting a mortgage?
Paying off credit card debt before applying for a mortgage can improve your chances of getting approved and getting a lower interest rate. Credit card debt affects your debt-to-income ratio, which is an important factor lenders consider when you apply for a home loan.
What should you not do when refinancing?
lender, do not refinance that debt with the same company.
You can ask the company to agree to lower payments on the existing loan, but you should not allow the creditor to write out a new loan, which is likely to involve hidden penalties and expensive new closing costs (or a higher interest rate).
Is it good to pay off credit card debt with home equity?
Usually, it’s better to pay off credit card debt with a home equity loan because it is issued in one lump sum and the rate tends to be lower than a HELOC. You’re still swapping an unsecured debt for one that uses your house as collateral, however, so think seriously about your ability to keep up payments.