How To Use A Debt Consolidation Mortgage Loan To Streamline Your Finances

Having multiple debts can be overwhelming. Credit card balances, personal loans, medical bills, and other obligations can pile up, making it difficult to keep track of due dates and monthly payments. If you find yourself struggling under the weight of high-interest debt, a debt consolidation mortgage loan may help provide some financial relief.

In this article, I’ll explain what a debt consolidation mortgage is, who it can benefit, its pros and cons, and alternatives to consider. My goal is to provide a comprehensive guide to help you determine if consolidating debt into your mortgage is the right move for your situation.

What Is A Debt Consolidation Mortgage Loan?

A debt consolidation mortgage loan allows you to roll multiple debts into a new mortgage loan or refinance your existing mortgage for a higher amount to pay off your other debts. This process essentially transfers your high-interest debts like credit cards, personal loans, and medical bills into your mortgage balance.

Since mortgages tend to have much lower interest rates than other forms of debt, consolidating through a mortgage refinance can potentially save you thousands of dollars in interest charges over time. You get the benefit of having just one monthly payment at a lower interest rate instead of keeping up with multiple payments.

There are two main types of debt consolidation mortgage loans:

• Cash-out refinance: You refinance your mortgage for more than what you currently owe, allowing you to take some of your home’s equity as cash to pay off debts. This increases your mortgage balance and monthly payment but allows you to pay off balances immediately.

• Rate-and-term refinance You refinance your current mortgage balance into a new loan to obtain a lower interest rate This keeps your loan amount the same but can potentially lower your monthly payment.

No matter what type you choose, the goal is to reduce the amount of interest you pay on your debts so more money goes toward paying down the principal balances.

Who Can Benefit From A Debt Consolidation Mortgage?

If you meet certain criteria, consolidating debt into your mortgage loan can be a smart financial move:

• You have a strong credit score. Having a credit score of 620 or higher will help you qualify for the best mortgage refinance rates. The higher your score, the lower your interest rate.

• You have equity in your home. For a cash-out refinance, you’ll need at least 20% equity in your home to qualify. Home equity is the current market value of your home minus the amount you owe on your mortgage.

• You have steady income. Lenders want to see you have a reliable income that can support the new, larger mortgage payment. Underwriters typically look for a debt-to-income ratio below 50%.

• You owe high-interest debt. The most ideal debts to consolidate into a mortgage are those with double-digit interest rates like credit cards. The larger the interest rate gap from your mortgage, the more money you’ll save.

• You plan to stay in your home. Refinancing costs money upfront through closing costs and resetting the loan term. So you need to stay long enough to recoup the costs through monthly savings.

If your circumstances align with the above criteria, read on to learn more about the pros and cons of debt consolidation mortgages.

The Pros Of Debt Consolidation Mortgage Loans

Here are some of the biggest benefits borrowers can gain by rolling debts into a mortgage refinance:

Lower Interest Rate

The main incentive for consolidating debts into a mortgage is scoring a much lower interest rate, which will lower the monthly payments. For example:

• The average mortgage interest rate is around 7% as of January 2023.
• The average credit card APR is currently over 19%.

With a 12% interest rate gap or more, you stand to save a tremendous amount on interest charges over time by refinancing credit card balances into your mortgage.

Single Monthly Payment

Instead of tracking multiple due dates for all your debts, you’ll have just one mortgage payment due each month. This simplifies the payment process.

Pay Off Debts Faster

Because more of your payment goes toward principal when you have a lower interest rate, you can pay off your consolidated debts faster.

Tap Home Equity

With a cash-out refinance, you can access your home equity, which is the forced savings you’ve accumulated by paying down your mortgage over time. This allows you to pay off debts immediately.

Shorten Loan Term

If you currently have a 30-year mortgage, you could refinance into a 15- or 20-year term. This allows you to get debt free faster since the loan amortizes quicker.

Improved Credit Score

Paying off credit cards and other debts can improve your credit utilization ratio, raising your credit score over time. Higher scores save you money on future loans and credit costs.

The Cons Of Debt Consolidation Mortgage Loans

While consolidating debts through a mortgage refinance has benefits, there are also some potential drawbacks to consider:

Closing Costs

It costs money to refinance. Closing costs include origination fees, appraisal fees, and other settlement charges that can total 2% to 6% of the loan amount. With a $200,000 mortgage, you may pay around $4,000 to $12,000 to close the refinance.

Lower Home Equity

When you do a cash-out refinance, you reduce your home equity because you’re borrowing against your equity to pay off debts. This leaves you with less of a financial cushion tied to your home.

Risk Of Default

If your new mortgage payment proves unaffordable and you default, you could lose your home to foreclosure. Work with your lender to ensure your new payment fits your budget.

Higher Long-Term Costs

Even though your monthly payment may decrease, you’ll likely end up paying more interest over the life of the loan because you’re extending the repayment term. Make extra principal payments when possible to combat this.

Origination Points

You may have to pay loan origination points on a refinance, which are upfront interest charges based on a percentage of the mortgage amount. Points lower the rate but add to your upfront costs.

8 Vital Tips For Refinancing Mortgage To Consolidate Debt

If you determine a debt consolidation refinance aligns well with your financial situation, here are some tips for doing it right:

1. Check your home equity

Make sure you have enough equity to qualify for the refinance program you want. Loan-to-value ratios of 80% or below typically provide the most favorable terms.

2. Compare mortgage rates

Shop different lenders to see who offers the lowest rate and fees. Comparing loan estimates helps you find the best overall value.

3. Examine closing costs

Ask lenders to disclose all closing fees so you can accurately calculate the breakeven point where savings from the refi surpass closing costs.

4. Evaluate the terms

Knowing the loan term, interest rate type, and monthly payment options allows you to model the financial impact over time.

5. Check your credit

Review your credit reports and scores from all three bureaus to correct any errors before applying. This helps you qualify for better rates.

6. Calculate savings

Use an online refinance calculator to compare your current debts against the proposed refinance so you can quantify potential savings.

7. Watch out for spending

Avoid racking up more high-interest debt after you consolidate or it defeats the purpose. Develop a budget to help control spending.

8. Make a payoff plan

Come up with a strategic repayment plan where you pay extra toward principal each month to pay off your mortgage faster and recoup home equity.

Following these tips will help you consolidate existing debts into your home loan the smart way.

5 Alternatives To Debt Consolidation Mortgage Refinancing

While consolidating debts into your mortgage can make sense, it’s not the only option. Here are a few other ways to tackle debt:

• Balance transfer credit card: Transferring balances to a card with a 0% intro APR allows you to pay down balances faster over 12 to 18 months.

• 401(k) loan: Borrowing from your 401(k) lets you pay yourself back over 5 years at low interest. No credit check needed but limits and risks apply.

• Home equity loan: Gives you a fixed-rate loan using home equity as collateral without refinancing your main mortgage.

• Personal loan: Unsecured loans have higher rates but don’t put your home at risk. Good for modest debts.

• Debt management plan: A credit counselor consolidates your debts and negotiates lower rates and payments with creditors.

Look at the pros and cons of each method above to find the debt payoff strategy that best aligns with your financial situation.

Key Takeaways On Debt Consolidation Mortgage Loans

• Refinancing your mortgage to consolidate high-interest debts like credit