Benefits of Cash-Out Refinance for Debt Consolidation

Not that you’ve noticed, but inflation hit 9% last year. While the inflation rate is coming down, no doubt you’re feeling the effects.

A common issue is rising debt to pay for everyday expenses. Credit card balances are piling up, plus many households have auto and student loans, too.

Here’s how to replace high-interest consumer debt with a cash-out refinance, plus the costs and benefits of doing so.

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Benefits of debt consolidation cash-out refinance

1. Increased cash flow: As inflation rises, monthly budgets tighten. A cash-out refinance can help increase your cash flow. For example, you have a $20,000 remaining balance on an auto loan with a $750 payment. Your credit card totals are another $20,000 with a minimum payment of $600 per month. Wrapping both these debts into a cash-out refinance at 7.5% would increase your mortgage payment by $280 per month and eliminate $1,350 per month, assuming you have a 7.5% rate currently. Your new mortgage payment could increase a lot more if your current rate is low. Read on for alternatives to cash-out refinancing for debt consolidation.
2. Improved credit score: A cash-out refinance can potentially improve your credit score. It does this by reducing your credit utilization ratio—an indicator of the amount of available credit you’re using. However, be disciplined. Keep your credit card accounts open but avoid racking up further debt. Closing these accounts can hurt your credit score as it reduces your overall credit availability.
3. Streamlined payments: Juggling multiple payments can be stressful and confusing. A cash-out refinance allows you to consolidate these payments into one—your mortgage. This simplifies your financial management, reducing the risk of missed payments.
4. Lower interest rates: The interest rate on a mortgage is typically far lower than that of a credit card. By paying off high-interest credit card debt via a lower-interest home loan, you can potentially save thousands over the life of your loan.
5. Free up cash: A cash-out refinance can free up cash for other purposes. You could start investing, build an emergency fund, or finance a large purchase.
6. Fixed interest rate: Unlike credit cards, which often have variable interest rates, a cash-out refinance typically comes with a fixed interest rate. This makes your payments predictable, helping you budget.

Remember, a cash-out refinance is not a silver bullet. It’s a tool that, when used wisely, can help you manage your finances better. But it also requires discipline.

For example, if you use the cash you get from the refinance to pay off your credit cards, then rack up more credit card debt, you’ll end up in a worse position than when you started.

Downsides of debt consolidation cash-out refinance

1. Extended payments: With a cash-out refinance, you’re stretching your credit card debt over the life of your mortgage—potentially 30 years. Instead of eliminating your debt quickly, you’re spreading it out, which could mean paying more in interest over time.
2. Reduced home equity: A cash-out refinance involves tapping into your home equity. This increases your loan amount and decreases your home’s equity. If property prices drop, selling your home might become a challenge. You might even need to bring cash to the closing table.
3. Higher mortgage payment: By increasing your mortgage loan, your monthly payments will likely rise. If your financial situation changes and you can’t meet these higher payments, you risk foreclosure.
4. Closing costs: Refinancing isn’t free. You’ll have to pay closing costs, which are typically in the 2% to 5% range of the loan amount. Make sure you factor these costs into your calculations.
5. Potential for additional spending: With a sudden influx of cash, there may be a temptation to spend recklessly. It’s crucial to use this money responsibly and stick to your financial plan.
6. Longer time in debt: With a cash-out refinance, you’re essentially starting your mortgage clock all over again. If you were close to paying off your mortgage, this might not be an appealing option.

Consider these downsides carefully. A cash-out refinance is a major financial decision that can have long-term implications.

Always consult with a trusted financial advisor or mortgage professional before making such a move. They can help you examine your situation and guide you through the process.

Debt consolidation cash-out refinance alternatives

If you evaluate your cash-out refinance options and ultimately decide that it’s not for you, there are several other financial paths you might want to consider.

HELOC

A Home Equity Line of Credit allows you to use your home equity how you would a credit card—only using as much as you need at that time—rather than taking out a lump sum loan.

• Lower closing costs: HELOCs typically come with lower closing costs than a cash-out refinance, making them a more cost-effective option.
• Unaffected primary mortgage rate: With a HELOC, your low-rate primary mortgage remains untouched. You’re essentially taking out a second loan, separate from your existing mortgage.

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Personal loan for debt consolidation

Personal loans can be applied for through your bank or credit union, in a designated amount.

• No collateral: Unlike a cash-out refinance, personal loans are unsecured. Your home isn’t at risk.
• Fixed payments: Personal loans offer fixed interest rates and payments. You know exactly what you owe each month.
• Quicker payoff: Personal loans typically have shorter terms than mortgages. You could be debt-free sooner.
• No closing costs: Personal loans don’t require closing costs. This saves you money upfront.
• Higher interest rate: A downside of this strategy is that most personal loans will come with a higher interest rate than you would likely find with a cash-out refinance.

More ways to avoid the cost of refinancing a mortgage for debt consolidation

Not every solution is going to work in every situation. Here are some alternative ways to consolidate your debt, without having to pay to refinance.

• Balance transfer credit card: Consolidate your high-interest credit card balances onto a card featuring a lower interest rate or a promotional 0% APR period.
• Financial reevaluation: Carefully examine your spending patterns and implement adjustments to allocate additional funds towards debt repayment.
• Debt settlement: Engage in negotiations with your creditors to reach a mutually satisfactory agreement, settling your debts for an amount less than the full outstanding balance. Keep in mind that this can lower your credit score.
• Bankruptcy: If all else fails, you might contemplate resorting to filing for bankruptcy, as it has the potential to alleviate or reorganize your financial obligations. Again, this will have a significant impact on your credit and you won’t be able to buy or refinance for years afterward.
• Credit counseling programs: Collaborate with a reputable nonprofit credit counseling agency to devise a budget, prioritize debts, and explore viable options for managing or consolidating debt.
• A straightforward refinance: Consider refinancing your mortgage to reduce your interest rate and potentially unlock funds to address your debts.

The cost to refinance a mortgage

There are two main costs to a cash-out refinance:

1. Closing costs
2. Potentially higher rate

Closing costs: You might spend 2-5% of the loan amount in closing costs. Don’t use a cash-out refinance if you just need a few thousand dollars. Spending $5,000 in closing costs to access $5,000 in cash is a 100% interest rate!

Higher rate: Most homeowners have a lower rate than what they could get for a cash-out refinance at today’s rate. Still, it might pencil out to go from 6.5% to 7.5% if you are consolidating a 25% credit card balance. Figure out your true interest savings.

There are costs for sure, but a cash-out refinance can put many homeowners in a better position for monthly cash flow and long-term savings.