Even if your financial situation is stable, refinancing can still help you save money by reducing your monthly payments or finding a lower interest rate. However, one of the most overlooked benefits of refinancing is debt consolidation. If you’re a homeowner with high interest debt on credit cards or personal loans, refinancing so you can draw on your home’s equity can be an excellent way to lighten your debt load. It’s common for people to have thousands of dollars in interest-bearing debt, and consolidating that debt into a lower-rate mortgage can save thousands of dollars in interest payments.
Here’s how it works: A cash-out refinance is essentially a new mortgage for more than you owe on your current one. You use the excess cash to pay off other debts. For instance, if you owe $150,000 on your mortgage and your house is worth $300,000, you could do a refinance for $200,000 and use the extra $50,000 to pay off high-interest debt. This strategy can simplify your financial picture by consolidating multiple payments into one, often at a lower interest rate than credit cards or personal loans.
But that too is risky. Refinancing to pay off unsecured debt with a secured loan (on your home) means you can risk foreclosure on your home if you fall behind on the new payments associated with the debt. Also, you should have a plan for managing your new mortgage payments, and not fall into the trap of taking on more debt by consolidating.
Furthermore, the net savings from a cash-out refinance can be eaten up by the costs of refinancing, including closing costs, appraisal fees, and points. Weigh the long-term benefits of lower interest payments against the front-end costs of refinancing to assess whether you can afford it.
As with any strategy for dealing with debt, talking with a financial adviser can help you analyse whether debt consolidation through refinancing makes sense for your situation. Also, consider the other options available, such as budgeting, debt management plans or balance transfer credit cards, before moving to a refinance if they make more sense. The bottom line is that your refinancing decision should be one that helps your financial health in the long term.
