Years ago, it used to be tough to decide whether to refinance your mortgage and use those savings toward paying off other debts. But today, the stakes in such a decision are the lowest they’ve ever been.
That’s because mortgage rates are some of the most competitive we’ve seen in history. Homeowners have the opportunity to borrow long-term money at the cheapest, lowest rate ever, leveraging their house as an asset.
Is it time to refinance and pay off other debts or loans? Gut instinct might have you immediately considering how you can eliminate your highest interest-rate credit cards and other loans. But there are some important factors to consider first:
- Does it make sense to pay off debts with this kind of loan? As noble as it sounds, sometimes using newfound money from a mortgage refinance to get rid of other debt isn’t the best choice. Is there a much-needed item for your household that you need? Should you put the money toward you or someone else’s education? Do you need to build up your emergency fund? Have you been waiting to pay for an essential home repair project? Also, sometimes certain debts can be lowered every month just by communicating your financial situation with that lender. Remember, there’s a difference between paying off a debt versus paying it down to a lower level.
- Application and documentation. Refinancing means dissolving your existing mortgage and entering into a new mortgage, which means you need to pre-qualify (a 20 – 30 minute conversation with your credit union). If needed, be open and willing to work on raising your credit score (FICO score) and lowering your debit-to-income ratio (DTI). As you eventually apply for a mortgage to replace your existing one, these steps may help.
- Can you stick to the plan? It’s your choice, but don’t get dollar signs in your head for buying new things when you originally started the refinance process to better your financial situation. You can focus on paying off one debt or multiple debts. First, focus on any debt you have a hard time staying current on. Next, focus on debt with the highest interest rate(s). It could be anything… credit cards, retail merchandise financing, personal loans, medical debt, education/school debt, auto loans — you name it.
- Selecting a product. With a traditional refinance, you can save some serious money every month which you can transfer to pay off other debt with higher interest rates (or pay down to a lower level). Simultaneously, you might even be able to reduce or eliminate your Private Mortgage Insurance (PMI) assuming your current mortgage is a certain type of government-program loan (FHA, VA, or USDA) and you’ve gained enough home equity. However, a cash-out refinance would instantaneously hand you the money you want — usually thousands of dollars.
- Closing Costs. Oftentimes these can be incorporated into your new mortgage amount and monthly payment, but don’t assume this. Make sure you understand the exact details before moving forward. It will all make financial sense if the closing costs are much less compared to the money you’ll save and transfer into paying down other debts.