There’s no question the economy has improved tremendously since the financial crisis of 2007-2008, when stocks on the U.S. Dow Jones hit a low of 6,600. Today in August 2016, the Dow is hitting record highs over 18,000. Unfortunately, good economic times don’t always serve all people equally. Even in our improving economy, individual credit card debt levels are “trending significantly upward.” According to MarketWatch, U.S. credit card debt could hit $1 trillion dollars by the end of 2016. A survey by NerdWallet.com says the average U.S. household credit card debt is $15,310. On top of that, an average of over $2,500 a year is being paid on credit card interest alone. That’s over $200 dollars a month for something people aren’t even getting anything in return.
If you include additional debt from auto, student and other loans, the numbers go much higher. A growing burden for many homeowners, personal debt creates financial stress, draining money away from where it could be going, like savings and investments, home improvement, or necessary everyday expenses.
Refinancing your mortgage is a possible solution for reducing or eliminating this type of debt once and for all. Before you start, below is what you need to know.
The Benefits of Refinancing for Debt Relief
To begin with, mortgage interest rates are much lower than credit card rates, which currently average around 15%. Interest payments on a mortgage are also usually tax deductible,* while credit card interest is not. The main reason most people refinance is to lower their interest rate and monthly payments. This alone can free up hundreds of dollars each month that could go toward paying down debt.
However, achieving relief from the amount of average personal debt in the U.S. requires more than a couple hundred dollars a month. Depending on how much debt you have, cash-out refinancing is probably your best choice. This type of refinancing lets you turn a portion of your home’s equity into cash to use however you like. Debt relief is one of the most popular reasons people choose this type of refinancing. Here’s how it works:
Equity is the difference between your home’s value and how much you owe on your loan.
|If your home’s value is||$300,000|
|And you still owe||$200,000|
|Your equity is||$100,000|
Cash-out refinancing lets you receive a portion of the $100,000 equity as cash. If you choose to take $25,000, after refinancing your new mortgage will look like this:
|Equity you turned into cash||$25,000|
|Plus what you still owe||$200,000|
|Your new mortgage is||$225,000|
It’s important to notice your new mortgage will be at least $25,000 more than what you currently owe. Your home’s equity is reduced by the same amount. You can think of your home equity like other financial assets you’ve worked for. Cash-out refinancing then gives you access to a large single lump sum of money, providing the help to get out from under high interest credit card bill and other personal debt.
Reasons to be Cautious when Refinancing for Debt Relief
When you use refinancing in this way, you switch from unsecured to secured debt. What’s the difference? If you default on unsecured loans or credit card bills you could get sued, you might be able to resolve the matter through bankruptcy, and your credit will be severely hurt. It’s bad, but the consequences can be even worse if you default on a mortgage. It’s a secured loan for which your house is used as collateral. If you default on a mortgage, the lender can foreclose on the house and you could potentially lose your home.
You have to understand your personal debt does not technically go away. You combine it with what you owe on your mortgage. What you do get rid of are one or more high interest loans, credit card bills, and multiple debt payments each month in exchange for a much lower interest rate and one single, lower monthly payment.
It also costs money to refinance. There are appraisal and closing costs. These can often be rolled into the loan, reducing what you have to pay up front. Just keep this in mind and figure out how long it will take for the costs to be offset by your savings. Or, maybe simply being able to eliminate personal debt combined with short-term savings and lower monthly are all worth the cost.
So be careful and pay close attention to exactly how your financial situation would change using cash-out refinancing. Remember, you’ll end up with a larger mortgage than you currently have. However, by getting a lower mortgage interest rate and a longer term, you could actually end up with lower monthly mortgage payments than you currently have. After using the cash-out money to pay down or eliminate your debt, you could potentially free up many hundreds of dollars a month to save and for other expenses.
Most importantly: no matter what, you should take steps not to repeat the spending patterns that created high debt in the first place. Once you reduce or eliminate your personal debt, you have to be responsible with the extra money you have. Redouble your efforts to stick to a household budget. Find expenses you can eliminate. Put money away each month so you don’t have to rely on your credit cards for emergencies or unplanned expenses.
Contact a PrimeLending home loan expert who will help you run the numbers to find out if refinancing is the right solution to help you reduce or eliminate your personal debt.
* The consumer should consult a tax adviser for more information about the deductibility of interest and charges.