Josh Moody: Should You Refinance Your Home to Pay Off Debt?

We have some debt we would like to pay off with the equity in our home. Our interest rate is actually lower than the current rates we could get in the market. Does it still make sense to refinance? What should we consider?

It depends.  Using equity in your home to pay off existing debt can be a very wise financial move depending on some different factors.

One of the most important of these factors is what type of debt are you paying off?  If we are talking about some high interest credit cards with high balances, then yes, it would typically be a wise move to refinance your home and pay this debt off, even if it means slightly increasing your current mortgage rate.  If you have had credit card debt before, you know that they are very difficult to ever get paid off due to the typically high interest rates. The high minimum monthly payments barely touch the principal balance.  So, paying those off and eliminating that debt would be to your advantage.  Or if you have done some home improvements or renovations and financed the work and/or materials at a higher interest rate, it would be wise to consolidate that type of debt all into one fixed rate payment.

On the other hand, if you are looking at refinancing your home to pay off something like a car loan that has a relatively low interest rate, maybe a year or two left before it’s paid off, you wouldn’t necessarily want to do that since you would be taking a debt that would pay off in a couple of years and rolling it into a 15 or 30 year loan.  It may seem attractive to eliminate that payment in the short term, but long term you are paying more interest.  So, the type of debt you are wanting to pay off is an important consideration in your decision.

The next thing to consider is how you would pull the equity out to pay off the debt.  One option is to do a cash out refinance.  This means your new loan amount would include the payoff of your current first mortgage plus the additional funds needed to pay off the debt. Typically, depending on credit and loan program, a cash out refinance can utilize up to 80% of the appraised value of your home. For example, if your home appraised for $200,000, you could borrow a maximum of $160,000.  The advantages of this type of loan are that you can put the entire balance under one lower fixed rate, and it will pay off in a set number of years.

Another option could be a home equity line of credit (HELOC) or a fixed rate second mortgage.  With these types of loans, you don’t do anything with your first mortgage, but you would borrow the funds to pay off the debt with a separate mortgage loan secured by your home.  These are typically offered by banks and credit unions.  The advantages are that they will normally allow a borrower to utilize more equity in their home (sometimes up to 90% or 95% of the appraised value).  The disadvantages are that HELOCs usually aren’t going to be a fixed rate. Normally they are tied to Prime Rate which can move from time to time or, if they are a fixed rate product, it will be a higher interest rate.

So, using your home’s equity to pay off existing debt can be a great way to help your family reach your financial goals, and there are some different ways to accomplish those goals.  Reach out to a mortgage professional and let them walk you through the best options for your situation.

Josh Moody is with The Mortgage Center Powered By Hometown Lenders. He has almost 20 years experience in the mortgage business. You can submit a mortgage question to Josh for his weekly column by sending an email to [email protected]. Disclosure: The Mortgage Center/Hometown Lenders is also an advertiser in The Gardendale News.