Refinancing When You're Overextended

Mortgage insurance is an option if a refinance won't fit loan-to-value limits.
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When you refinance your home mortgage, you get a new loan to replace your existing one. People refinance loans for a few common reasons. Getting out from under a load of debt payments is one. If you've taken on more expenses and debt than you can handle, refinancing may be the way to get some relief. It can help reduce your monthly expenses by replacing high-interest debt like credit card debt with lower-interest mortgage debt and, in extreme cases, may even protect you from default or foreclosure.

Refinance Objectives

Saving money on interest, reducing monthly payments and getting cash out of the home are three common reasons to refinance. If you bought a home when interest rates were higher, refinancing to a lower rate can save you a lot of interest over time. Refinancing to a new loan usually reduces payments because your interest rate is lower and your new loan term may be longer. A cash-out refinance means you get a new loan that exceeds your current loan and take the excess as cash, which you can use to pay down other debt, like your credit cards.

Debt-to-Limit Ratios

Lenders use debt-to-income ratios when you apply for a loan to prevent you from taking on more debt than you can manage. Conventional lenders use a 36 percent debt-to-income and 28 percent mortgage-to-income limit. FHA lenders use 41 percent and 29 percent, respectively. Your monthly debt cannot generally go over the percentage of your monthly income used as a guideline. Sometimes, common lender guidelines don't tell the whole story. You may have unusual expenses, like alimony or charitable giving, outside of those factored in to your ratio. You may have taken on new expenses or increased debt through personal loans or credit cards. If you feel stress and pressure all the time about your finances and are using credit cards, this is a practical sign you are overextended.

Reigning in Debt

When you refinance, you usually can get a short-term loan, maintain your existing repayment term or extend to a longer term. Assume you originally got a 30-year fixed loan at 5 percent. You have paid on it for five years. You currently owe 25 years' worth of balance. With a goal of reducing your monthly debt expenses, you would choose to refinance with another 30-year loan. This reduces your monthly expenses in two ways. Your interest payments on the loan balance fall because of a lower interest rate. Also, your current loan balance is less than it was originally because you have paid on it for five years. Spreading the current balance out over 30 years means you owe less in each installment.


Refinancing to a new mortgage when you are struggling financially has challenges. Lenders consider your income and debt situation and generally require you to pay closing costs to get the new loan. If your income and debt situations have worsened since the original loan, you may no longer meet loan requirements. In a down housing market, your home's value may fall below your original loan amount or affect your loan-to-value ratio. Lenders typically require no more than an 80 percent LTV, or sometimes even 75 percent, for a conventional refinance as of the time of publication, according to You may need to refinance to a lower mortgage and use cash to pay off some of your original loan, or find an alternative way to get your new loan within LTV limits. You can also negotiate directly with your lender to come up with a solution that helps you and allows you to pay the loan back.

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