Refinancing and debt reduction

Posted by  on Mar 20, 2011

Did you have your heart set on doing a cash-out refinance to pay off debt but can't find a lender willing to let you tap home equity? Many mortgage lenders are unwilling to let homeowners receive cash back at closing because so many properties have declined in value in recent years. But that doesn't mean refinancing can't be a part of your debt reduction plan.

Cash out refinance pros and cons

While a cash-out refinance may seem like the best solution to your debt woes, that may not be the solution even if you can qualify for one. Getting cash back at closing can give you a lump sum of money to pay down credit cards and other debt, which can be a good thing. But a drawback to getting cash at closing is that you are decreasing your home equity. Home values have dropped significantly as the housing market has struggled, and drawing down equity now could eventually result in you owing more on your mortgage than the property is worth if housing values continue to fall.

Refinance rates are low

Depending upon when you bought your home, refinance rates may have declined significantly. You may be able to shave hundreds of dollars off monthly mortgage payments depending upon the mortgage loan balance and refinance rates you are quoted. But getting lower mortgage payments is just part of the equation. It's important to know how much a refinance is going to cost.

Recovering the cost of refinancing

Financial experts used to advise against refinancing unless you could decrease the interest rate at least 2 percentage points. But you may be able to save a ton of money even if you can reduce interest by only 1 percentage point. Do the math, or have your loan agent help, to determine at what point you would break even on the cost of doing a home refinance.

Put monthly savings toward debt

Shaving a few hundred dollars off home loan payments can give you more money to put toward debt. Put together a list of all non-mortgage debt to determine exactly how much is owed. Totaling up everything might be a shock, but it's important to do this to work up a debt reduction plan. Instead of using the savings from a refinance to buy more stuff, use it to retire one of your debts. Once you've paid off the first debt, roll over the payment into the next debt. Continue to do this until all debts are paid.

Other solutions to debt problems

You may be disappointed that mortgage lenders are unwilling to approve a cash-out refinance. But if refinancing can allow you to drop the interest rate and monthly mortgage payments, it may be worth considering to improve your overall financial situation.



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