Consolidating Debt Into a Mortgage Refinance

If you’re struggling to manage debt, taking on a new loan might seem like a bad idea. For some debtors, however, using a new loan to pay off debt could give you the help you need, particularly homeowners who take out a mortgage refinance loan.

As a homeowner, refinancing can give you access to extra cash that you can use for debt consolidation. The right loan can also potentially reduce your interest rate and help you pay off your debt faster.

What Is Mortgage Refinance Debt Consolidation?

Debt consolidation is the act of using a new loan or a new credit card to pay off multiple debts. For homeowners, one way to consolidate debt is by refinancing your mortgage and borrowing more than you need to pay off your first loan, then using the extra funds to pay off credit cards or loans.

Why would you use a mortgage refinance to consolidate your debt? There are a few reasons to consider making this big move. First, refinancing can potentially get you into a new mortgage with a lower interest rate or lower monthly payments. Second, it can reduce your overall interest charges on your debts if you use the new loan to pay off accounts with higher interest rates, such as credit cards.

In other words, consolidating debt through a mortgage refinance can potentially help you manage debt in a few ways.

“The monthly cost of the refinancing may be lower than the monthly cost of the higher-interest debt,” Adam Spigelman, senior vice president of portfolio retention at Planet Home Lending, said. “You can apply it to your highest and most expensive debts to free up monthly cash flow.”

Pros and Cons of Consolidating Debt with a Mortgage Refinance

Refinancing your mortgage to pay off debt can help you save money and may even speed up your journey to becoming debt free.

But it’s not without its drawbacks. Lender fees for refinancing can be substantial, and the new loan can increase your risk of losing your home. Plus, debt consolidation doesn’t decrease your debt balances or solve deeper financial problems like overspending or under-earning.

“It is important not to incur new high-interest revolving debt after your refinance, or it could simply perpetuate the debt problem,” Spigelman said.

Pros

If you find the right mortgage refinance loan to consolidate your debt, you could benefit in a variety of ways:

• Fewer accounts to manage: When you consolidate multiple debts into one, you’ll have fewer payments to track and manage each month.
• Potential for lower interest rates: The main reason to consolidate debt into your mortgage is because mortgage interest rates are typically much lower than other types of debt, especially credit cards. In mid- 2023, the average APR on a credit card was 20.68% and it was 11.48% on a 24-month personal loan was 11.48%, versus 7.18% for a mortgage.
• Have a set debt-payoff date: With credit cards, you can potentially make the minimum payment for years and never make a substantial dent in your debt. But with a mortgage refinance, you’ll have a set date when the debt will be paid off.

“Ask your current mortgage servicer for a rate quote because they often have deals for existing customers,” Spigelman said. “Plus, if you stay with the same lender that has your current loan, you won’t typically have to fund a new escrow account.”

Cons

There’s no guarantee that using a mortgage refinance for debt consolidation will help you save money or pay off debt faster. These are the serious downsides to consider:

• Putting your home at risk: Unlike credit cards and personal loans, mortgage refinance loans are backed by your home as collateral. That means you risk foreclosure if you fall behind on the loan payments.
• Your credit score could be an issue: Your credit score will determine whether or not you get approved for a mortgage refinance and what rate you qualify for. If you don’t have a good credit score, you may only be able to get approved for high interest rates.
• Potential increase to your mortgage payment: If you roll old debts into your mortgage payment, the monthly payment on your mortgage could increase. You can extend your repayment term to lower your monthly payment, but that means you’ll accrue more interest charges on the debt and take longer to repay the loan.
• Lender fees: The lender may charge closing costs of 2%-5% of the new loan amount. On a $200,000 refinance, the fee could range from $4,000-$10,000.
• Not good for federal student loan debt: Consolidating federal student loans means losing payment flexibility. For example, if you roll the debt into your new mortgage, you’ll no longer have access to The Department of Education’s income-driven repayment options.

“Read the fine print on closing costs,” Spigelman advised. “When you see ads that say, ‘no closing costs,’ chances are the lender is paying those costs for you via a higher rate or adding them to your home loan. What they really mean is no “out-of-pocket” closing costs.”

Should You Refinance Your Mortgage To Consolidate Debt?

You should only consider refinancing your mortgage to consolidate debt if you know the new loan meets all of these criteria:

• It reduces the total interest charges you’ll pay on all of your debt.
• It will save you money, even after you pay the lender’s fees.
• You can comfortably afford the monthly payment.

If the new loan doesn’t meet these requirements, it’s a bad move. Instead of rolling your debts into your mortgage refinance, you may want to consider other solutions, whether that be a different kind of loan or seeking financial or legal guidance from a professional.

» Learn More: Can You Consolidate Debt Into a New Loan?

Alternatives to Consolidating Debt Into Your Mortgage Refinance

Consolidating debt into a mortgage refinance is definitely not the only way to manage debt, and it may not be the cheapest solution. If you’re looking for an alternative to help you get a handle on your debt, consider these options:

Personal loans. Personal loans can be used to pay off pre-existing debt, and they can be a good choice for consolidating credit card debt since the interest rates on personal loans are typically much lower than credit cards.

Debt management plan (DMP). A debt management plan is a program you may be able to enroll in through a nonprofit credit counseling agency. If you qualify for a DMP, you’ll make one monthly payment that the agency disburses the payment to your creditors. You should be able to get reduced interest rates, fees and/or monthly payments.

Balance transfer credit card. A balance transfer credit card is a card that comes with 0% APR on debt you transfer onto the card during a limited “introductory” period of time. Transferring debt onto one of these cards can give you time to pay down the balance without having interest charges added to what you owe. However, these cards typically have a 3%-5% transfer fee.

Bankruptcy. If you can’t find a way to pay off your debt within the next 3-5 years, you may want to consider filing bankruptcy. Bankruptcy is a legal solution that can result in having some or all of your debt dismissed, or in setting up an affordable monthly payment for your debts. Filing for bankruptcy can cause a major drop in your credit scores, but for some people it’s the only way to become debt-free.

Get Help Consolidating Your Debt

Even if you’re approved for a mortgage refinance to consolidate your debt, taking on the loan could still be a bad idea. If you need someone to help you weigh the pros and cons of the new loan, or to run through the alternatives with you, consider speaking to a certified, nonprofit credit counselor.

A credit counselor can walk you through all of your options for debt help, from taking out a loan to filing chapter 13 bankruptcy. They can also run the numbers to help determine if a mortgage refinance loan is truly in your best interests.