You may have large outstanding debt on one or more credit cards. You may also be struggling to make any significant dent in paying the debt down; especially if you’re only making minimum payments. With interest rates making up a significant portion of each payment, it might take years to pay off the balance.
When you factor in that most credit cards have variable interest rates, your minimum payment amount increases as the rates climb. And with multiple credit cards – each with different due dates and their own minimum payment amounts – you may feel as if you’re drowning in debt. But there is a potential lifesaver; if you already have a mortgage, you can apply for a cash-out refinance loan and use the funds to consolidate and pay off high interest credit card debt, medical expenses or college tuition.
What is a cash-out refinance loan?
It’s when a homeowner secures a new loan to replace the current mortgage for more than the amount currently owed and keeps the difference between the old and new loans. The homeowner is then able to use the additional cash refinanced to help pay off any debt.
Why should I get one?
One of the many advantages to using a cash-out refinance to pay off your high interest debt is the lower interest rate this secured loan typically offers; it’s usually much lower than any of the high rates on your credit cards.
The average credit card rate is substantially higher than the average 30-year mortgage rate. In fact, the interest on credit card debt and even car loans could easily be double that of your mortgage rate. The reason? Credit card debt is considered riskier than mortgage debt so the credit card companies charge interest accordingly. As such, using a cash-out refinance loan can help you pay off your credit card debt much sooner, since less of your money is going toward interest payments.
By transferring debt from a financial vehicle that charges more to less, you can save a considerable amount of money. And if you consolidate the debt, you will see immediate monthly savings in your payments. You’ll also eliminate multiple bills; it can be very confusing paying several credit card and car loans which have different due dates during the month. If you consolidate, you will only need to pay one bill per month, your mortgage.
The other important advantages to using a cash-out refinance loan to pay off debt, include:
- Access to money you already have to pay off big bills including college tuition, medical expenses, new business funding or home improvements
- It’s usually available at a more attractive interest rate than found on unsecured personal loans, student loans or credit cards
- The interest rate is more stable than the adjustable rate that comes with the other debt reduction instrument, a home equity line of credit (HELOC)
- Increase your credit score because when you use the funds to pay off high-interest credit card debt, it not only eliminates the higher-interest monthly payments, but can have a positive impact on your credit score
- The mortgage interest is tax deductible and the debt may be tax deductible as well
Cash-out refinancing and a home equity loan – what’s the difference?
Some people aren’t sure of the difference between cash-out refinancing and a home equity loan. Here are some of the major distinctions to look for:
- A cash-out refinance is a replacement of your first mortgage, while a home equity loan is a separate loan on top of your first mortgage
- The interest rate on a cash-out refinancing loan is usually, but not always, lower than the interest rate on a home equity loan
- You may pay closing costs when you refinance your mortgage, while you don’t typically pay closing costs with a home equity loan
The Bottom Line
It’s important to note that while a cash-out refinance loan can reduce your high interest debt, it’s not a panacea. It is a great solution to provide immediate debt relief, but the best practice is to take steps, such as save more or reduce discretionary expenses so that you don’t end up with an unmanageable amount of high interest debt. If this sounds like a solution you might be interested in, start by talking with an experienced mortgage professional or loan officer to find out what your best loan options are for reducing high interest debt.
From the PrimeLending blog by Jack Honig