Should you refinance your mortgage to pay off debt?

Debt can be overwhelming — especially if you have a lot of it. If you’re looking for ways to simplify the payoff process and save money on interest, mortgage refinancing is one sound option. Below, we’ll dive deeper into how to refinance to pay off debt so you can determine if it makes sense for your unique financial situation and goals. 

What is mortgage refinancing?

When you refinance your mortgage, you replace your existing mortgage with an entirely new one. In turn, you can access cash or change your mortgage terms to free up more of your monthly cash flow. 

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You can refinance with your current lender or a different lender. Similar to applying for a mortgage to purchase your home, you’ll need to complete an application, submit some documents, authorize a credit check, and go through an underwriting process. 

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A mortgage refinance can help you repay a number of high-interest debts, such as credit card debt, medical debt, personal loan debt, and even private student loan debt.

The benefits of mortgage refinancing for debt payoff

There are several reasons you may want to refinance your mortgage to pay off debt, including:

• Lower interest rates: Mortgage refinance rates tend to be lower than rates on other types of debts. If you refinance with a competitive rate, you’ll save a lot in interest.
• Single monthly repayment: By refinancing your mortgage to repay debt, you can simplify the payoff process. You’ll have a single monthly payment instead of multiple payments with different due dates to keep track of. 
• Potential tax benefits: Are you looking to pay off debt and make a few upgrades around your home? If you use a portion of the funds on home improvements, you may be able to deduct the interest you pay on a mortgage refinance from your taxes. If you’re looking for ways to lower your tax bill, this is a solid advantage
• Improved cash flow: Since refinancing your mortgage helps you save on interest — and potentially leads to lower monthly payments — it can free up your cash flow.  You can enjoy more money in your pocket and focus on rebuilding your financial health.
• Enhanced financial stability: The less debt you have, the more financially stable you’ll be. You’ll find it easier to cover your expenses, save for retirement, and lead the lifestyle you want. 

The potential risks of mortgage refinancing for debt payoff

Like any financial strategy, refinancing your mortgage to pay off debt comes with drawbacks you should consider, such as: 

• Hidden fees and costs: Most lenders charge closing costs to process a mortgage refinance. These may be anywhere from 2% to 6% of the total loan amount. You can pay them upfront or roll them into your new loan. Other hidden fees may include appraisal fees, loan origination fees, and title insurance. 
• No guarantee of a lower rate: When you apply to refinance your mortgage, you won’t automatically receive a lower interest rate. If you decide to refinance at a higher rate, your mortgage payments will increase. 
• Risk of default: Since your home is used as collateral, the lender may foreclose on your home if you fall behind on your payments. Other debts, like credit cards and personal loans, are unsecured and usually come with more fees if you cannot pay. 
• Negative impact on home equity:  Refinancing can hinder your home equity. If your home value drops, you may have an underwater mortgage and owe more than your home is worth. This can make it a challenge to sell or refinance your property down the road.
• Temptation to take on additional debt: While a mortgage refinance can help you repay high-interest debt, it won’t stop you from overspending and racking up more debt. It’s up to you to keep your spending in check, even if you have more disposable income due to a lower interest rate or longer terms. 

Is a mortgage refinance to pay off debt a good idea? 

Whether or not mortgage refinancing to repay debt is a good idea depends on your particular situation. By considering these factors, you can determine whether this strategy is worth pursuing: 

• Debt level: Refinancing makes sense if you can pull enough from your equity to cover your debts. Otherwise, in addition to paying closing costs and fees, you'll have to continue paying any debts you couldn't eliminate. 
• Interest rate: If you qualify for a mortgage with a rate at least 1% lower than your debt and mortgage rate, you may benefit from a refinance. Otherwise, refinancing may not help improve your finances as much as you’d hoped. 
• Fees: It's up to you to cover fees and closing costs, which usually range from 2% to 6% of the loan amount. You'll want to crunch the numbers and determine if you can afford a refinance and whether you'll save money on your debts after paying these costs. 
• Spending habits:  Be honest with yourself and determine how likely you are to avoid debt in the future. If your current situation requires you to take on more debt, refinancing would only be a band-aid. It may be worthwhile to consult a financial advisor instead. 

Types of mortgage refinancing

There are two main types of mortgage refinancing worth exploring:

Cash-out refinancing 

With a cash-out refinance, you take out a new mortgage larger than your existing one. The new loan pays off your current mortgage and lets you pocket the difference in cash. 

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Your cash-out refinance loan will have a traditional mortgage repayment term, like 15 or 30 years. To qualify, you generally need a minimum credit score of 620 and at least 20% in home equity. Upon approval, you can then use the cash to repay high-interest debts. 

Rate-and-term refinancing 

A rate-and-term refinance is when you alter your mortgage to a different interest rate, term, or both. It can help you secure a lower rate, shorten your term to reduce your interest costs, or extend your term to make your monthly payments more affordable.  Typically, you’ll need at least 20% equity in your home and a credit score of at least 620 to get approved for a rate-and-term refinance. You can then put the extra money you save towards your high-interest debts. 

Alternatives to mortgage refinancing to pay off debt

If you decide that refinancing isn’t right for your particular situation, here are some debt relief alternatives to consider:

• Home equity line of credit (HELOC): A HELOC can allow you to access your home equity as a revolving credit line. You can borrow as much or as little as you'd like, up to a set credit limit over a 10-year withdrawal period. Then, the balance turns into a principle-plus-interest loan you repay over a payment term – often 20 years – in monthly installments. HELOCs generally come with lower rates than rates on credit cards and other types of debts, but the rate is variable. It may be difficult to get a HELOC with bad credit, so be sure to shop around.  
• Home equity loan: A home equity loan is much like a HELOC. The difference is that you'll receive a lump sum of cash rather than a line of credit and repay it immediately via fixed monthly payments. Terms for home equity loans usually range from 5 to 30 years. As long as you have strong credit, you may get approved for a home equity loan at a lower rate than the rates you're paying on your current debts.
• Home Equity Investment (HEI): Similar to a home equity loan, an HEI offers a lump sum today in exchange for a portion of your home's future appreciation. There are no monthly payments; repayment is when the 30-year term ends or you sell or refinance your home. If you have less-than-perfect credit, you're more likely to qualify for an HEI than a HELOC or home equity loan.
• Debt consolidation: Debt consolidation allows you to roll multiple high-interest debts into a single account. As a result, you’ll only have one monthly payment to keep track of, which can simplify the payoff process. Consider refinancing credit card debt with a personal loan or 0% APR credit card, or explore a consolidation loan to eliminate car, mortgage, or personal loan debt.

Tips to successfully refinancing your debts

If you decide to refinance your mortgage to repay your debts, keep these tips in mind.

• Shop around for the best rates: It’s best practice to do your research and zero in on the lowest rate. Get pre-approved with multiple mortgage lenders, including your current lender, to compare rates and other terms. 
• Compare rates on your debts and the new rate: Once you determine what rates you qualify for, compare them to the rates you’re currently paying on your credit cards and other high-interest debts. Ideally, you’d be able to qualify for a refinance rate that is at least 1% lower to see any actual savings on your debts. 
• Factor in closing costs and other expenses: Consider the fees involved in a mortgage refinance, such as closing costs and the appraisal fee. It’s important to tally all the expenses up and ensure the savings outweigh the cost of refinancing. 
• Think long-term: Debt can be stressful, but you shouldn’t rush into refinancing your mortgage to pay it off. If you’re unable to secure a lower rate, have to extend the terms significantly, or may not be able to handle higher payments in the long term, it may not be worth it. 
• Maintain responsible financial habits: Remember that mortgage refinancing to repay debt won’t magically fix your finances. It’s up to you to live within your means and avoid taking on new debt.

Final thoughts

Ultimately, your unique needs and financial health should guide whether you refinance to pay off debt. If you can qualify for a lower rate than the rates you're paying on your current debts, for example, this strategy may set you up for financial success. It's particularly true if you have a good handle on your spending and feel confident you won't take on more debt. However, if you feel overwhelmed but find a refinance isn't right for you, it's important to explore alternative options.