Refinancing your home to pay debts can save you thousands on dollars in interest, but you've got to consider the benefits and drawbacks of a refinance first. A refinance, also known as a remortgage, is when a borrower gets a new home loan to pay off an existing one. When you refinance, you'll have the option of getting money back from the loan as long as you have equity in the home. Equity is the part of your home's value you own, free of any debts or liens.
Savings and Convenience
If you're using your mortgage money to pay off higher interest debt, you'll save over the long term. For example, let's say you have a $10,000 balance on a personal loan with a 24 percent interest rate. That works out to $2,400 in interest. If you take out a mortgage with a fixed interest rate of 5 percent and use some of the money to pay off that personal loan, you'll save yourself around $1,900 in interest. If you have a lot of high-interest debt, you can save thousands of dollars. Once you've paid off debts, you'll only have the one mortgage payment each month, as opposed to several payments to different creditors. Simplifying your bill paying makes it easier to budget.
A common trap homeowners fall into after refinancing to pay debts is racking up new debt. After you've paid off your debts, you'll free up current lines of credit and may be tempted to open up new lines of credit. It's very easy to fall back into old spending habits once you have more money available. You may find yourself saddled with your old debts and a new mortgage payment if you're not careful. You need to create a budget so you don't fall into this trap. Unlike as with unsecured debt, such as credit cards, the lender can take your home if you can't pay the new mortgage.
You still have to qualify for the new mortgage. If you have good credit and meet the lender's other requirements, you'll get a lower interest rate. If you have poor credit, you'll have difficulty getting a loan with a low rate. A mortgage with a high interest rate will likely cost you more over the long run and may not be worth getting. When you're looking for mortgages, consider a fixed-rate loan so you know what your payment will be each month. While an adjustable rate loan might have a lower interest at the start, your rate will go up once the loan resets on the date set by the lender.
You'll need to look at your debts before refinancing to make sure fees and penalties won't eat away at your savings. Depending on the debt type and your credit agreement, you may have prepayment penalties. A prepayment penalty is a fee — usually a percentage of your debt — the creditor or lender will charge you for paying off what you owe early. You'll have out-of-pocket costs when you refinance. Common expenses include title fees, appraisal fees, bank charges — including an application fee — and other expenses related to closing a home loan. While the costs vary by lender, loan type and amount, you might end up paying thousands of dollars, as the expenses can be as high as six percent of your loan amount.
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