If you're attempting to improve your overall financial picture, you’ve probably heard financial gurus preach the importance of paying off debt. Refinancing your mortgage can seem like a practical way to pay down credit card balances, medical bills, personal loans, and other expenses. In some cases, it can work. A refinance may help you replace multiple payments with one mortgage payment, and mortgage rates are often lower than credit card rates.
But refinancing to pay off debt isn't a simple swap. It can increase your mortgage balance, extend your payment timeline, and add closing costs. A refinance may lower your monthly bills, but it doesn't erase the debt; it simply changes how you repay it.
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Questions to Ask Before You Refinance
A trusted lender can help you compare refinance options, but you may also want to talk with a financial advisor or tax professional before deciding whether refinancing to pay off debt makes sense.
Ask about the pros and cons before deciding which home refinancing option is right for you.
Talk through questions like these:
- How much would each refinance option save monthly and annually?
- What are the total closing costs?
- Will closing costs be paid upfront or rolled into the loan?
- How long will it take to break even on the refinance?
- How much equity will remain in the home after refinancing?
- Are you eligible for a tax deduction?
- Will the new loan extend your repayment timeline?
- Will the new loan lower your credit score, even temporarily?
- Is the refinance worth using your house as collateral?
- How quickly can you pay down your debts after you’ve freed up some cash?
Don't assume that the interest on refinanced debt will be tax-deductible. Check the current IRS guidelines.
Two Common Types of Refinancing
There are two common refinance options homeowners may consider when trying to pay off debt: a cash-out refinance and a rate-and-term refinance. They work differently, so the right fit depends on your goals, current loan, available equity, and long-term plans.
Cash-Out Refinance
Homeowners with a large amount of high-interest-rate debt often consider a cash-out refinance first. This kind of refinance lets you take money from your home’s equity to pay off other debts, but you’ll end up with a higher principal balance.
In simple terms, you’ll apply for a new mortgage loan, pay off the original, and use the leftover money to pay your bills. The new, higher-balance loan amount replaces your old loan. Keep in mind that you probably won’t have the money in hand until three to five days after closing.
Ultimately, you’ll need to run the numbers to feel confident that you can afford the new mortgage payment and potentially PMI to determine if refinancing to pay off debt makes sense.
Qualification requirements vary by loan type and lender, but lenders generally review your credit history, income, debt-to-income ratio, home equity, loan-to-value ratio, and appraisal.
Rate-and-Term Refinance
If your debt load isn’t high and you think your numbers look good enough to qualify for a lower interest rate, consider a rate-and-term refinance. This type of refinancing changes your loan term and/or interest rate, but doesn’t change your principal mortgage balance.
After submitting income paperwork to your lender, scheduling an appraisal, and meeting the underwriter’s qualifications, you’ll pay your original loan balance and open a new loan with a lower interest rate and longer loan term. You’ll lower your mortgage payment each month to funnel your savings into other bills like credit cards or medical debt. You won’t need PMI, but you will pay more interest over time.
VA Refinancing Options
If you’re a veteran or current service member, there’s a good chance you’ve used a VA loan to buy your house, as VA home loan rates are very competitive. You already know about the benefits of your original loan, but you may not know about the VA’s refinancing options.
There are two main VA refinancing loans: the VA Streamline, also known as the Interest Rate Reduction Refinance Loan (IRRRL), and the VA Cash-Out Refinance. Both are similar to the rate-and-term refinance and cash-out refinance options, but they’re tailored to veterans with VA loan eligibility.
VA Streamline Refinance or Interest Rate Reduction Refinance Loan (IRRRL)
Veterans who already have a VA or FHA loan can use a streamline refinance to secure a lower interest rate and reduce monthly mortgage payments.
It’s the refinancing option with the least amount of paperwork and, often, the lowest number of closing costs. You can also roll closing costs into your overall loan amount, sometimes without an appraisal.
VA Cash-Out Refinance Loan
The VA lets service members tap into their equity with a cash-out refinance loan. The VA cash-out refinance loan replaces your existing mortgage, similar to a non-VA loan cash-out refinance. The VA’s cash-out refinance also lets qualified veterans with conventional VA home loan rates apply without taking cash from their equity, if they choose.
Instead, they simply refinance for a lower interest rate for a longer time. With a VA cash-out option, you can finance your closing costs (and the VA funding fee) into your new loan if you have enough equity to meet your lender’s requirements for the loan-to-value ratio.
Is Refinancing a Good Way to Consolidate Debt?
Refinancing can be a good way to consolidate debt for some homeowners, but only when the savings outweigh the costs and the new mortgage remains affordable. The goal isn't just to lower your monthly payment; it's to improve your overall financial picture without putting your home at unnecessary risk.
Not every refinancing solution will help you save money. You could end up paying more than the debts you owe. If you’re considering VA refinancing loans or other financing options, investigate online refinance calculators to get an idea of your payments. Compare the interest rate, APR, closing costs, loan term, monthly payment, funding fee, and total interest over the life of the loan.
Refinancing your home to pay off debt can be helpful, but it's not always a reset button. Make sure the new loan supports your long-term financial goals.
