When you consolidate debt, you use money from a new loan to pay off debts from other sources like credit cards and medical bills. Consolidating lets you make one payment to one lender, which makes bills easier to manage. You can also save money on interest when your new loan has a lower interest rate than the loans you want to consolidate.
When is debt consolidation worth it?
Consolidation can be a good idea when the interest rate on your new loan is significantly lower than the rate on your current debts. For example, homeowners sometimes think about consolidating credit card debt with a cash out refinance which allows them to get cash from the value of their home’s equity. This can make sense because the interest rate on credit cards is often several times higher than the interest rate on a mortgage.
This kind of debt consolidation might help you save money in interest payments over time. Like with any loan, be sure you understand the rates, payments, and the closing costs you might pay.
When is debt consolidation not worth it?
Debt consolidation might not be the right choice if you can pay off your current loans in a short period of time. That’s because you might pay more money in closing costs for a debt consolidation loan than you save on interest. Also keep in mind that if overspending is a reason you are in debt, your finances may not improve unless you fix your spending habits.
Pros of debt consolidation
- Single payment. Debt consolidation allows you to make a single payment to one lender instead of juggling multiple bills that are due on different days with varied (and often higher) interest rates.
- Interest rate savings. Many credit cards have high interest rates and consolidating your debt can lower the amount of interest you pay over time.
- Credit score. Though debt consolidation loans typically require a credit check that could lower your credit score, consolidating your debt generally raises your credit score over time. This is possible when you make your payments on time and lower your credit utilization ratio.
- Get debt-free sooner. If you’re able to make extra payments each month because your new loan term or interest rate is better it might help you pay off your debt more quickly.
Cons of debt consolidation
- Fees. Debt consolidation loans and balance transfer cards all typically require you to pay fees. Make sure the benefit of consolidating your debt outweighs the additional cost you have to pay.
- Total interest payments over time. Two factors that influence how much money you pay for interest are the rate on your loan and how long you take to pay the loan back. For example, you typically pay more money in interest if you pay off a loan in ten years than if you pay it off in five years. As result, look at the total amount of interest you’ll pay over the life of your old debts and your new debt consolidation loan before you make your decision.
- Spending habits. If you went into debt because you struggle sticking to a budget, consolidating your debt will not fix your long-term finances unless you change your behavior.
Cash out refinance for debt consolidation
A cash out refinance replaces your current mortgage with a new mortgage for a higher amount and gives you the difference in cash at closing. You can use this cash to pay down or pay off other debts.
The interest rate and term may be different on your new mortgage. Your monthly payment is likely to be higher, the amount you owe will increase since you are adding to your mortgage balance, and refinancing will likely increase the total amount of interest you pay over the life of your loan.
Cash out refinancing requirements for debt consolidation
You will be required to complete a mortgage application, provide financial documents, and pay closing costs to get a cash out refinance. Look at all the interest costs and fees before deciding a refinance is right for you.
You will also need available equity in your home to get a cash out refinance. You can estimate your equity by taking the current value of your home and subtracting how much you owe on your mortgage and other home loans. If your house is worth $250,000 and you owe $150,000 on a mortgage for example, you have $100,000 in equity.
Talk to Freedom Mortgage about getting cash from your home equity
Freedom Mortgage can help you tap into your home’s equity with cash out refinances for conventional, VA, and FHA loans. Ask us today if you qualify for cash out refinancing!
Speak to an experienced Loan Advisor today by calling 877-220-5533 or completing our web form by visiting our Get Started page.
* Freedom Mortgage Corporation is not a financial advisor. The ideas outlined above are for informational purposes only, are not intended as investment or financial advice, and should not be construed as such. Consult a financial advisor before making important personal financial decisions and consult a tax advisor regarding tax implications and the deductibility of mortgage interest.