How To Consolidate Debt With a Mortgage Refinance

Debt is ubiquitous in America — but not all debt is created equal. Some debts, like credit cards and personal loans, come with high interest rates. Other debts, like mortgages and student loans, have lower interest rates. Refinancing your mortgage can be one way to consolidate high-interest debt into low-interest debt.

Here’s a closer look at how a debt consolidation refinance works, and how to decide if it makes sense for your financial situation.

Refinancing To Consolidate Debt: How It Works

If you’re a homeowner, refinancing your mortgage to pay off higher-interest loans can have huge financial benefits. A debt consolidation mortgage refinance can lead to significant interest savings, lower monthly debt payments, and a brighter long-term financial outlook.

One of the reasons why many people refinance is to lower their interest rate. Getting a lower interest rate helps make your monthly payments more affordable and helps you save on overall interest.

However, it’s important to factor in refinance closing costs to make sure you’ll be saving enough money to make the process worth it. In 2023, refinancing closing costs average $5,000, so you should aim to save more than this over time.

Options To Consolidate Debt With a Mortgage Refinance 

If you want to consolidate debt with a mortgage refinance, there are several options available. 

Cash-out refinance

With a cash-out refinance, you receive a payout at closing by drawing from your home equity and increasing your loan amount. You can use the cash from a cash-out refinance to pay off other higher-interest loans. Doing so effectively consolidates your loan balances into a single new mortgage, ideally with a lower interest rate.

Cash-out refinance example

Let’s say you have three credit cards with interest rates above 20% and balances around $20,000 each, in addition to a mortgage. At a minimum, you must pay $400 per month for each credit card. It will take years to pay off your balances, according to your monthly credit card statements.

You have an estimated $150,000 in home equity, which was calculated by subtracting your mortgage balance from your appraised home value. With current mortgage rates, you believe you can refinance debt with an interest rate of around 8%, which is much lower than your credit card interest rates.

You find a lender you like and apply for a cash-out refinance. You’re approved for the $60,000 in cash out you would need to pay off your three credit card balances. While your mortgage payments may increase, this will help you eliminate $1,200 in monthly credit card payments and save significantly on interest in the long run.

Rate-and-term refinance

A rate-and-term refinance is when you refinance to change the terms of your mortgage to be more favorable without altering your principal. If your financial situation, your credit score, or market interest rates have changed, a rate-and-term refinance could save you money or lower your monthly payment.

Using a rate-and-term refinance, you can extend your loan term, which will lead to lower monthly payments but higher interest costs over the life of the loan. The new loan terms could give you enough extra cash each month to quickly pay off high-interest debt.

Rate-and-term refinance example

Let’s say you have a 15-year fixed-rate mortgage. Your monthly payment is $2,000, and you’re struggling to keep up. You decide on a rate-and-term refinance to extend your loan term and lower your monthly payments. When extending to a 30-year fixed-rate mortgage, your monthly payment becomes $1,500, saving you $500 per month. While your total interest paid will increase with the new loan, you may decide the lower monthly payment makes the refinance worthwhile.

VA cash-out refinance

If you used a Veterans Affairs loan to buy your home, you may qualify for a VA cash-out refinance. One benefit of a VA cash-out refinance is the ability to borrow up to the property’s value in some cases, enabling you to get more cash from the equity in your home.

A VA cash-out refinance may be easier to get and offer better terms than a cash-out refinance on a conventional loan. Check with your preferred lender to find out if it supports VA loans, and discuss which option could be best for you.

Alternative Options To Consolidate Debt

Refinancing your home isn’t the only way to consolidate debt. If you want to leave your mortgage as is, these options could work for debt consolidation.

Here’s a deeper look at debt consolidation options outside of a mortgage refinance.

Personal loan

A personal loan is typically available with no collateral. Some banks, credit unions, and online lenders offer personal loans for various uses, including debt consolidation. If you have multiple high-interest credit cards and qualify for a personal loan with a favorable rate, you can use the loan to pay off your credit card debt.

Some lenders offer personal loans using collateral, such as a car, cash in a savings account, investments, or valuables. With collateral, you may qualify for a lower interest rate. However, if you don’t pay the loan as agreed, you could lose the items securing your personal loan. 

With or without collateral, personal loans typically have higher interest rates compared to a traditional mortgage secured by your home.

Balance transfer credit card

With a balance transfer credit card, the issuer allows you to move your balances from other credit cards. In many cases, the issuer pays off your other credit cards for you, or you can use a credit card convenience check to pay off your other cards yourself.

With balance transfer credit cards, look out for higher interest rates or high fees for performing the balance transfer. Some credit cards let you transfer a balance and pay no interest for a period, potentially allowing you to save money while making progress on your total balance.

HELOC

A home equity line of credit is a second mortgage that borrows from your equity and uses your home as collateral.

A second mortgage is another loan secured by your home that you take out while you already have an existing mortgage. Because it’s tied to your home, you may get a better interest rate with a HELOC than you would with credit cards and other types of debt.

HELOCs allow you to draw on the credit line up to the limit. When you use your HELOC to pay off credit cards or other loans, you’re effectively consolidating your loans into one.

Home equity loan

A home equity loan is a second mortgage that cashes out your equity as a lump sum, whereas a HELOC can be used repeatedly over a certain period, up to the limit. Like with a HELOC, your home is used as collateral, which can get you a lower interest rate. However, you could lose your home if you stop paying your loan as agreed.

Debt consolidation loan

Some lenders offer loans marketed as debt consolidation loans. With this type of loan, multiple high-interest debts are converted and simplified into a single loan payment, typically with a lower interest rate.

While your interest rate and monthly payment may be lower, the term is usually longer, which means you’ll pay more in total than if you didn’t use a debt consolidation loan. Also, some debt consolidation loans start with lower introductory rates that increase over time.

5 Steps To Consolidate Debt With a Cash-Out Refinance 

If you want to know how to refinance debt with a mortgage, these are the general steps to follow:

1. Determine how much equity you have. Start by calculating your approximate home equity, as that’s around the upper limit of what you can borrow. It’s best to not borrow more than 80% of your home’s value to avoid the added cost of private mortgage insurance.
2. Add up the debt you’d like to consolidate. Next, list out the interest rates and outstanding balances of all the debts you’d like to consolidate. You need to compare interest rates to ensure you’re consolidating with a loan that’s a better deal. To pay off your outstanding balances with a cash-out refinance, you’ll need enough home equity to cover those balances.
3. Shop around. It’s time to find a refinance loan that meets your needs. You may need to shop around with several mortgage lenders to find the best interest rates and other terms that suit you.
4. Close on your new mortgage and get cash out. Go through the approval process required by your chosen lender. Your credit score, debt-to-income ratio, and overall financial health will play a role in the approval process. You’ll likely have to submit tax returns, bank statements, pay stubs, and other financial documents to prove you qualify for the refinance.
5. Use your cash out to pay off other loans. The refinance lender most likely won’t pay off your high-interest debts for you. Instead, you’ll receive a check or wire transfer for the cash-out amount.

If you use a rate-and-term refinance, you’ll save money over time rather than receive a lump sum. You can use the monthly savings to make larger payments to pay off high-interest debts faster. That’s not consolidating your debts in a traditional sense, but it may lead to a similar result, where you’ll only have one loan — your mortgage — left to pay off.

Pros and Cons of Refinancing To Consolidate Debt

Using your home as a tool to consolidate and refinance debt can be financially beneficial, but there are potential risks and downsides to consider as well. Here’s a look at the pros and cons of refinancing to consolidate debt.

Benefits of Refinancing To Consolidate Debt

Here are some of the advantages of consolidating debt with a mortgage refinance:

• More affordable payment. This is one of the biggest benefits of refinancing to consolidate debt. If you’re struggling to keep up with monthly debt payments, refinancing can help those payments become more manageable.
• Savings on interest. One of the top reasons to refinance your house to pay off debt is to get charged less interest. If you can lower the interest rates on the balances you owe, then you’ll save money on interest every month.
• Improved credit score. High balances on your credit cards can hurt your credit score. If you want better credit, paying off your revolving debt through a debt consolidation could be a good move.
• Opportunity to change the terms of your loan. Refinancing can help you switch to a new loan that’s better for your finances. For example, if you have an adjustable-rate mortgage, switching to a fixed-rate loan locks in your rate, preventing future interest rate increases.
• Debt payments become more manageable. With only a single monthly payment to handle, it can be easier to manage your debt after consolidating.

Drawbacks of Refinancing To Consolidate Debt

The costs and risks associated with refinancing to consolidate debt aren’t always worthwhile. These are some drawbacks to consider:

• You may fall back into high-interest debt. Unless you change your budget, you could quickly find yourself racking up credit card debt or other high-interest debt again. Adjusting your spending habits and staying away from new debt is important to avoid paying more in interest.
• Higher risk. If you stop paying your credit cards, your credit will suffer. In comparison, if you stop paying your mortgage, you could lose your home.
• Additional costs. Refinancing isn’t free. Closing costs and other charges can be significant.
• More years of debt. By refinancing, you could reset the clock on your payoff date. For example, if you’re seven years into a 30-year loan term and you refinance to a new 30-year mortgage, you’ll lose seven years of progress toward owning your home free and clear.
• PMI payments. If your new loan causes you to drop below 20% home equity, you could find yourself owing PMI payments on top of your regular mortgage payments. PMI protects the lender if you stop paying but offers no major benefits to borrowers. It’s simply an added cost.

Tips for Refinancing To Consolidate Debt

If you decide to move forward with refinancing to consolidate debt, following these tips can help ensure the best outcome.

“Compare rates and terms from multiple lenders to ensure you get the best deal,” says Steven Kibbel, a certified financial planner at Kibbel Financial Planning in Franklin, Tennessee. “Understand the terms of your new loan. … Once you’ve consolidated, avoid the temptation to rack up more debt.”

Pay off high-interest debt first

When refinancing, it’s best to pay off high-interest debt first. A higher interest rate means you pay more per dollar borrowed, even when your minimum monthly payment is lower. That’s why it’s smart to prioritize higher-interest debt if your home equity for a cash-out refinance is limited.

Work on your credit

Having good credit increases your approval odds and may help you get the lowest possible interest rate on your new loan. With bad credit, you could struggle to find a lender willing to give you a new loan, and may need to pay a higher mortgage interest rate after refinancing.

Build your equity

Refinancing to consolidate debts isn’t possible if you don’t have enough equity to pay off your outstanding balances. You’ll build equity over time by paying your mortgage or seeing your home’s market value increase naturally. It’s best to hold off on refinancing until you have enough equity built up to wipe out your other debts.

Be disciplined with your payments

Once you get your new loan, it’s important to always make at least the minimum payment by the monthly due date. Missed payments can harm your credit score and lead to additional fees. If you miss enough payments, you could end up in foreclosure and lose your home.

Research options

Before moving forward with refinancing your home, it’s wise to research your available refinancing options. Comparing other debt consolidation methods and shopping around for the best rates will put you in a better position for success.

FAQ: Refinancing To Consolidate Debt

Here are answers to frequently asked questions about consolidating debt with a mortgage refinance.

The Bottom Line on Refinancing To Consolidate Debt

Refinancing your home is a major undertaking, but it’s often worth the effort if you can save money or improve your financial situation in the process. Using a mortgage refinance to pay off debt is common and can lead to major savings in the long run. If you think debt consolidation makes sense for your finances, shop around for the best refinance terms so you can move forward confidently.