When our clients Jay and Lisa called us a few months ago they were on pace to pay off their mortgage within 12 years. There was just one little catch… at over $200,000, their consumer debt was out of control. As Dave Ramsey followers, they knew they had to address this if they were going to create a better financial future for themselves. They came to us asking “If we’re already in our mid 40’s, how are we going to pay off all this debt so we can enjoy our retirement years?”
We helped them create a debt consolidation refinance plan so they could to tap into the idle equity in their home and pay off their consumer debt. They took out a new first mortgage to pay off their current first and second mortgage as well as their credit card debt and two car loans. Now they’re taking that monthly savings and adding it to their student loan payments to pay them off even faster. In 4.5 years, when these are paid off, they’ll take that student loan payment and apply it to their mortgage. In just over 12 years, they’ll be completely debt free – that’s 5 years sooner than on their previous path!
Benefits of A Debt Consolidation Refinance
While consumer debt continues to increase in the US, so does home equity. Although Core Logic’s Home Equity Report(1) shows that home equity grew in almost every state, Colorado was in the top 10! We showed a significant increase – gaining an average of $17,000 per borrower last year.
If you’ve been considering a debt consolidation refinance, now may be the time to act. For folks who are disciplined with their money, this can be a great financial planning tool. By consolidating your high-interest debt into your monthly mortgage payment, you could reduce your average interest rate, your total monthly debt expense and pay less interest overall.
Though it can be a great option, consolidating credit card and other debt into your mortgage is not right for everyone. Consider these 5 questions before deciding whether it’s an appropriate choice for you.
1. How Much Equity Is in Your Home?
If you’re thinking about a debt consolidation refinance, you’ll need to be sure you have enough equity in your home. Your loan-to-value (LTV) ratio should be less than 80% after completing your refinance. To roughly calculate the potential LTV of a new loan, divide your current mortgage balance plus the cash out desired by the approximate value of your home. For example:
current mortgage: $250,000 + cash out: $100,000/approx home value: $500,000 = 70% LTV
2. Which Loans Will You Pay Off?
If you’re looking to pay off multiple loans with this debt consolidation refinance, keep in mind that depending on the amount of equity you have available, it may not be possible to pay off everything. In this situation, how do you determine which debts to pay off? Typically, we recommend paying off the loan with the highest interest rate first. However, you should also take into consideration the monthly payment, length of the loan and total interest expense. Longer term loans may end up costing you more in interest over the long haul, even if the interest rate is lower.
Keep in mind that refinancing doesn’t really pay off anything, it just moves your debt around.
3. How Will You Avoid Running Up Debt Again?
One of the biggest challenges after paying off debt? Not racking it right back up! If debt has been an issue for you, work on changing your spending habits first. Set a budget and get a sense of how much disposable income you actually have. Otherwise, you’ll end up back in the same situation in the near future, and this time your home could be at stake.
4. What Additional Costs Will You Pay?
A debt consolidation refinance (or cash-out refinance) carries the typical costs of a traditional refinance, such as closing costs, title fees, appraisal fees, etc. This type of loan also has a slightly higher interest rate; about .25% to .375% depending on factors like credit score and your new LTV. Be sure to factor these expenses in when determining if a cash-out refinance makes sense for you.
5. Are You Willing to Put Your Home on the Line?
Last, but certainly not least … a debt consolidation refinance takes high-interest, unsecured debt and rolls it into a mortgage secured by your home. If you’re struggling with personal debt to the point where you are or might consider bankruptcy, this is not a choice for you. If you lose your job or take out a refinancing loan that you can’t afford, you are much more likely to lose your house than if you were to declare bankruptcy due to excessive personal debt.
Bottom Line: Don’t refinance debt into a mortgage you can’t afford.
What Are Your Next Steps?
If you think a debt consolidation refinance is in your future, give us a call today and we’ll help you determine if it’s the right fit for you.
The information contained herein is general in nature and based on authorities that are subject to change. Churchill Mortgage guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Churchill Mortgage assumes no obligation to inform the reader of any changes that could affect information contained herein. This publication does not, and is not intended to, provide legal, financial, tax or accounting advice, and readers should consult their advisors concerning the application of tax laws to their particular situations.
1. https://www.corelogic.com/news/corelogic-reports-homeowners-with-negative-equity-increased-by-35000-in-the-fourth-quarter-of-2018.aspx
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