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Debt Consolidation Loan

Despite the current high-interest rates, there are still huge advantages in taking out a debt consolidation loan by doing a cash-out refinance on your home.

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The other day I was talking with a friend, who revealed her frustration that the costs of her divorce had maxed out her credit cards, and she was now $30,000 in debt.

Normally, she’d be fine, but the monthly charges on those cards were way over her budget, and she couldn’t see any way out.

After talking for a while I discovered that she had over $150,000 in equity in her home, so I suggested she consider taking out a debt consolidation loan by doing a cash-out refinance to significantly reduce her payments each month.

“But,” she asked, “how in the world could I do that with interest rates where they are right now?”

Let me share with you what I told her. 

I started with the basics:

What Is A Debt Consolidation Loan?

A debt consolidation loan (sometimes called a credit card consolidation loan) is a loan that takes all of your credit card and other debt (like auto and store card loans) and combines them into a single payment each month. That way you don’t have the hassle and risk of making multiple payments each month. 

And, because debt consolidation loans tend to be at a lower interest rate than credit cards, they also save you money, so your payment on that one loan is usually lower than the combined monthly payment your multiple cards would require.

While there are different types of debt consolidation loans, the best deal is to do a cash-out refinance of your mortgage.

What Is A Cash-Out Refinance Loan?

A cash-out refinance is a type of mortgage refinance where you get a new mortgage loan for an amount greater than the amount you currently owe on your home and use that difference to pay off your other loans.

Because your home secures this loan, it is considered considerably less risky by lenders, so the interest rate you will pay will be significantly less than what a different type of debt consolidation loan will charge you. And because mortgages are long-term (30, 15, or 10-year loans) the amount that will be added to your payment will be a fraction of what you were paying for those other high-interest loans.

My friend could do a cash-out refinance, taking out $30,000 more than the amount she currently owes on her home, and have considerably lower monthly payments overall. 

I’ll show you the math in just a moment, but first, let’s deal with her question about interest rates.

How Interest Rates Work

Interest rates are all interconnected. So, if the Fed increases interest rates by one percentage point not only are mortgage interest rates going to go up by around one point, credit card interest rates are going to do so too.

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The gap between mortgage and credit card interest rates usually remains about the same. 

But there’s one other thing about interest rates. Since the current high-interest rates are designed to solve a temporary inflation-related problem, most experts believe that once that problem is fixed, interest rates are likely to go back down to some lower rate, maybe not as low as they once were, but lower than they are right now.

When that happens, assuming your financial situation is solid, you can refinance your mortgage again, and get even lower rates.

So, if you have to take out a mortgage or refinance right now, there’s a good probability that you’ll be able to refinance in the future at a lower rate.

Is It A Good Idea To Do Debt Consolidation Cash-Out Refinance Right Now?

It all depends on your specific situation, but it probably is, even at these high-interest rates.

Let me show you why I say this by doing the math. 

My friend currently has 4 maxed-out credit cards totaling $30,000 in debt. The average credit card company has a minimum monthly payment of 1 – 3% of the principal (in this case, $30,000) plus interest. Let’s just say that she is required to pay 2% of that principal amount each month, so $30,000 * .02 = $600.

Then on top of that, they add interest and fees to get her minimum monthly payment. Let’s assume she is currently being charged an average of 20% interest for those debts. That will add $500 interest each month, making her required monthly payment $1,100 per month.

Now, let’s look at what she would be paying for a cash-out refinance. Let’s assume that the best she can do for her refinance is a 7% 30-year fixed interest rate. 

How much will she be paying on just the $30,000 part of the loan she’s using to pay off that credit card debt?

$198.43.

Yep, less than $200. That’s $900 less than she’d be paying to the credit card companies, $10,800 per year!

Do you think a $900 reduction in monthly payments would make a difference in her budget? In her life?

Refinancing Your Refinanced Loan

And remember what I told you that hopefully within the next few years, interest rates will drop again to lower levels, giving my friend the ability to refinance her loan again at a lower rate.

Or perhaps she could keep her payments the same by refinancing for a shorter time – 15 or even 10 years instead of 30 years. It is possible she could pay off the entire loan in half or even a third of the time at a lower rate without paying much more in house payment than her current bill.

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Are Cash-Out Refinances A Good Idea In 2022?

Yes, they can be, even at the current high-interest rates, as long as you use them wisely.

Because, as I pointed out to my friend, cash-out refinances can be a bad thing if you turn around and charge another $30,000 on those credit cards. 

Debt consolidation loans in the form of a cash-out refinance can be a powerful tool in giving you freedom from debt, but only if you discipline yourself to use them as a way to reduce your debt, not as a way to be able to add more of it.

Frequently Asked Questions

Do debt consolidation loans hurt your credit score?

Over time, when done correctly, debt consolidation loans can improve your credit score. As long as you make your payments on time and use them to reduce your total debt, rather than as an opportunity to max your credit cards out again, your credit score will eventually increase and your overall financial situation will improve.

How long does debt consolidation stay on your credit report?

If you do debt consolidation through a cash-out refinance, your credit score won’t go down by much at all. However, if you choose to do it through a debt settlement or bankruptcy, those will be a black mark on your credit report for around 7-10 years.

Is debt consolidation the same as cash-out refinance?

A debt consolidation mortgage is the same thing as a cash-out refinance. They’re the same process, but may be called by different names depending on the lender you’re working with.

Does debt consolidation give you cash?

When you do a debt consolidation or cash-out refinance, your lender will deposit the cash above and beyond the cost of paying off your prior loan and closing costs directly into your bank account. You can then use that money to pay off your other loans.

What are the disadvantages of debt consolidation loans?

The biggest disadvantage is that you may not be able to qualify for a debt consolidation cash-out refinance. The financial issues that got you to the point of needing that type of loan may make it so you cannot qualify for that loan. Also, you need to have sufficient equity in your home to be able to pull the extra cash out, which usually requires years of payments on your mortgage, a significant remodeling job on your home, and/or significant house price inflation (which has happened over the last several years.)

A second disadvantage is that once your credit card debt is cleared off, it’s fairly easy to charge more to those cards, running up your debt over time. That’s not a good idea. 🙂

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What are the risks of a cash-out refinance to pay off debt?

1. There is a risk that you could lose your home if you can’t make your payments. 

If you don’t do a debt-consolidation loan and can’t make your credit card payments, you will lose your credit score. But if you’ve rolled them into your mortgage through a cash-out refinance, and you can’t make your payments, you could lose your home.

2. There is a risk that you’ll add new debt.

There’s a natural tendency to charge more to your cards because your credit cards are empty, especially if you’ve been used to them being full for so long. You should avoid doing that, using your cash-out refinance as a tool for reducing your debt, not adding to it.

3. You may not be able to get the loan. 

Sometimes the financial situation that put you in the position of needing to get a cash-out refinance mortgage makes you an unattractive risk to a mortgage lender. You may need to pause, pay down some of that debt, and clean up your financial condition before you apply for a refinance loan.

Conclusion And Action Steps

Is a cash-out refinance a good idea for you right now? Only you and your lender can answer that question. 

But don’t let the currently high-interest rates prevent you from considering this option. Yes, those interest rates may be high, but they are probably significantly lower than you are paying on your high-interest credit cards.

Have Questions About Debt Consolidation Loan Or Other Mortgage Issues?

We can help! You can Ask Your Question here and we will connect you with a Mortgage Expert in your area that can help, or you can find a Mortgage Expert Near You below this article.

About the Author

Scott Schang

A 20+ year veteran of the Mortgage and Real Estate industry, I am passionate about educating and empowering consumers. I have been writing about consumer protection issues and making sense of complicated real estate and mortgage topics on this website since 2007

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