Refinancing Your Home to Pay Off Debt
If you’ve been tempted by low-interest retail and credit card offers or hit a dry spell in your earnings, you may have ended up with more debt than you planned. It can be a struggle to keep your head above water with minimum payments that don’t seem to make a dent.
Homeowners with debt—particularly credit cards or other loans with high-interest rates—have options to consider in leveraging their property to reduce other debts.
Should you refinance your home to pay off debt? Let’s take a look at your options and how they work to find out.
Can I Refinance My Home to Pay Off Debt?
For most people, buying a house is their biggest investment—but many forget that it’s an investment that you can leverage over time, not just a potential money-maker after a sale.
Refinancing a home can have multiple benefits, one of which is the ability to take out cash to cover other needs. It can also:
- Lower your monthly payment amount
- Reduce your interest rate and the total amount of interest paid
- Shorten the duration of your loan
If you opt for this type of mortgage refinance, it means that you’re renegotiating your loan to cover what you still owe on the house plus an amount of money handed over to you. You’re turning some of your home equity into cash. Cash-out refinance is frequently used to:
- Invest in major property repairs and upgrades
- Fund college educations
- Cover medical expenses
- Pay down higher interest debt
Can I Take Equity Out of My House to Pay Off Debt?
If you’re reluctant to go the cash-out refinance route, there are other ways to borrow against the equity you own in your house. Common approaches include:
- Home equity loans
- Home equity lines of credit
While these both leverage your home equity, there are significant differences between them.
1. Home Equity Loan
Home equity loans are also known as second mortgages. If you want to keep your primary mortgage as is, you can arrange a secondary loan that uses your available home equity as security.
Using a home equity loan to pay off debt is quite common for good reason. A reduced interest rate makes it appealing to exchange high-interest debt for a home equity loan. You’ll usually get lower interest on a secured loan than on unsecured debt such as credit cards.
On the other hand, a home equity loan for debt consolidation is secured by your house as collateral. That means that if you default on your loans, this lender is second in line to the house proceeds after your mortgage holder. The lender is taking a greater risk than your mortgage lender, so the interest rate will be higher than with a primary mortgage.
2. Home Equity Line of Credit
A home equity line of credit, or HELOC, is a bit closer to a credit card that’s funded by your house. When you take out a HELOC, be sure you understand:
- Draw period – You’ll have a set window of time during which you’ll have access to draw on your line of credit. You’re not required to actually borrow the full amount, although you might be required to take out a set minimum at the start of the draw period.
- Interest owed – You’ll owe based on what you borrow during the draw period, so if you end up needing less than the maximum, you’ll pay interest only on what you needed.
- Fees – Some HELOCs charge a fee each time you withdraw an amount during the draw period, and some charge for inactivity if you don’t end up using your line of credit.
- Repayment – You’ll have a set date after the draw period ends when you’re required to start making payments. Some HELOCs are set up so you’re initially paying just on interest before you begin paying down the loan balance.
If neither of those options work for you, there are other alternatives for learning how to get equity out of your home, without having to leave the home you love.
How to Refinance Your Home to Pay Off Debt
No matter what method you go with, if you’re looking to finance a loan based on your homeownership, it all starts with figuring out how much of the home’s equity you actually own. After that, the refinancing process is similar to your original mortgage and closing preparation: a lot of paperwork gathering and presenting yourself with the best borrower profile you can.
Step 1: Determine Your Home Equity
When you step foot in your first home, your home equity equals the downpayment you could gather. Every month after that, home equity shifts slowly from the bank to the homeowner.
But it’s not just about the payments you make—it’s also about your current home value. Over the long haul, real estate prices are a solid bet to go up. There are dips with specific neighborhoods. Likewise, local changes like a sharp drop in employment level, growth in crime, or natural disasters can lower property values. But for most homeowners, it’s common for your home value to increase year over year with basic upkeep and maintenance.
You can get a quick estimate of your current home value with an online calculator. For an accurate calculation, follow these steps to determine the home equity you can borrow against:
- Hire an appraiser to complete a professional valuation
- Figure out what you still owe on your home from a current mortgage statement
- Subtract what you owe from the market value to find your home’s equity
- Most lenders will limit you to borrowing 80% of your home equity
For example, if your home’s current market value is $250,000 and you still owe $150,000 on the original mortgage, then your home equity is $100,000. If a lender allows you to borrow 80% of that, it means you can borrow up to $80,000 against your equity (which will leave you with $20,000 in home equity).
Keep in mind that you’ll also need to pay closing costs on the loan. These can be rolled into the loan or paid out-of-pocket.
Step 2: Spruce Up Your Borrower Profile
Traditional lenders rely on set information to decide whether they’ll extend a loan to you and what the loan term will be. The better you look as a borrower on paper, the higher the chance you’ll receive a loan offer with the lowest interest rates and fees.
Be prepared by reviewing your borrower stats and identifying whether you can tweak anything for improvement within the timeframe you set to secure your loan. These include:
- Credit score – Many credit card companies now show your current credit score on your statement or online account. Check there first before paying or signing up for a service to access your credit score. It’s possible to qualify for a cash-out refinance with a credit score as low as 620, but a better score means a lower interest rate.
- Debt-to-income ratio – How much do you pay each month in total debt? Divide that amount by your gross monthly income to get your debt-to-income ratio. Lenders usually want to see no more than 45% DTI.
Are there claims to dispute on your credit report? Are there debts you can renegotiate to lower monthly payments? Ask potential lenders if either of these stats is affecting the rate and terms they’re offering you, and look into what you can do to improve them.
Step 3: Gather the Paperwork
No one’s going to ask for your high school grades or any IOUs you’ve scribbled onto bar napkins—the list of documents for home refinancing and loans is pretty predictable. Have these copies on hand to get detailed loan offers and compare before making any decisions:
- Current mortgage statement on the property you’re refinancing
- Homeowners’ insurance declaration page or policy
- Property deed with the legal owners’ names
- Title insurance providing a legal description of the property
- Signed tax returns from the past two years or other official proof of income
- Current statements from other debts (student loan, auto loan, personal loan, or credit card)
- Current statements from any outstanding home equity loan or line of credit
- Current asset statements (checking, savings, retirement, investment, CD accounts)
Additionally, if you’ve filed bankruptcy or have significant claims on your credit report, you may need to provide explanations in writing or further documentation.
Alternatives to Refinancing Your Home
Refinancing isn’t always a good fit. There are other approaches to paying down your high-interest debt, both independent of and still including the use of your home equity. You can:
- Negotiate with individual creditors to reduce your payments or waive fees
- Transfer outstanding credit card debt under a new zero or low-interest card offer
- Take out a debt consolidation loan
- Work with a nonprofit credit counselor on debt consolidation and negotiation
- Access your home equity directly through a sale-leaseback versus refinance home to pay off debt
A Better Way for Homeowners to Pay Off Debt
If you’re a homeowner, a sale-leaseback program can help you convert the equity you already own to overcome the pitfalls of high-interest debt.
Sale-leaseback solutions can keep you in your home as a renter while converting the equity you’ve built into cash, so you can free yourself from a debt burden. Consider reaching out to a financial advisor to explore your options.
If you’re looking for ways to pay off debt, refinancing might be the right option for you. There are multiple alternatives to paying off debt when discussing refinancing alternatives. If you are still unsure that refinancing your home to pay off debt is right for you, contact a financial advisor to discuss additional options.
- Investopedia. Cash-Out Refinance vs. Home Equity Loan: What’s the Difference? https://www.investopedia.com/mortgage/heloc/refinancing-vs-home-equity-loan/
- Federal Trade Commission Consumer Advice. Home Equity Loans and Home Equity Lines of Credit. https://consumer.ftc.gov/articles/home-equity-loans-home-equity-lines-credit#top
- Consumer Financial Protection Bureau. I got my free credit reports, but they do not include my credit scores. Can I get my credit score for free too? https://www.consumerfinance.gov/ask-cfpb/i-got-my-free-credit-reports-but-they-do-not-include-my-credit-scores-can-i-get-my-credit-score-for-free-too-en-6/
- NerdWallet. What Is a Cash-Out Refinance, and How Does It Work? https://www.nerdwallet.com/article/mortgages/refinance-cash-out
- Credible. What Documents Do You Need to Refinance Your Mortgage? A Checklist. https://www.credible.com/blog/mortgages/documents-needed-for-refinance/