Debt Consolidation Mortgage: Should I Get One?
A debt consolidation mortgage is a loan secured by your home that gives you access to funds that you can use to pay off outstanding debts. You’re likely to reduce your monthly debt load by consolidating all of your debts into a single loan, as mortgage rates are more affordable than the interest rates on, say, a credit card or personal loan. But whether you save money overall depends on your new interest rate, loan term and how quickly you repay the loan.
Before you decide to consolidate your debt using a mortgage, it’s important to understand your loan options and review their pros and cons. We’ll walk you through everything you need to know below.
- A debt consolidation mortgage allows you to use home equity to pay off higher-interest debts.
- Mortgage debt usually has lower rates, longer repayment terms and larger borrowing limits than unsecured alternatives.
- Cash-out refinances, home equity loans and HELOCs can all be used to convert high-interest debt to mortgage debt.
- Lower monthly debt payments don’t always mean lower lifetime borrowing costs.
What is a debt consolidation mortgage?
A debt consolidation mortgage is a home loan you take out and use the extra cash it provides to pay off car loans, student loans, credit cards or other debt.
If you choose a refinance, the loan will also replace your current mortgage; if you choose a second mortgage, it won’t. But, no matter which type you choose, your home equity secures the loan.
In many cases, you’ll be left with a single loan payment at a lower interest rate, which can greatly simplify your finances and save you thousands of dollars in interest charges.
When you convert nonmortgage debts into mortgage debt, you’re putting your house at increased risk. If you fail to keep up with your debt consolidation mortgage payments, you could lose your home to foreclosure. The same isn’t true if you default on car loans, credit cards or student loans.
How does a debt consolidation mortgage work?
A debt consolidation mortgage usually works a lot like a cash-out refinance, and may even be called a “debt consolidation refinance.” The main difference, however, is that you usually won’t receive the lump sum and then manually pay your creditors. Instead, the credit accounts are paid off through the closing process.
Your home equity secures the loan, and lenders will vet your finances to confirm you can afford the new mortgage payment. You’ll also need a home appraisal to confirm you have enough equity — most loan programs only let you borrow up to 80% of your home’s value.
Example: How a debt consolidation mortgage can save you money
Let’s explore how much you’d save by taking out a $247,000 debt consolidation mortgage refinance to pay off $47,000 worth of credit card and auto loan debt.
For the sake of our example, let’s say you’re carrying the following debts:
- $10,000 in credit card debt with a 4% minimum monthly payment. That’s at least $400 each month.
- $37,000 in auto loan debt at a 7.53% interest rate. That’s a $670 monthly payment.
- $200,000 on a home you paid $400,000 for. Your monthly mortgage payment is $2,100.
Here’s a breakdown of how a debt consolidation refinance mortgage would change your financial picture:
| Current scenario | Debt consolidation mortgage scenario | |
|---|---|---|
| Principal and interest mortgage payment | $2,100 | – |
| Monthly debt payments | $1,070 | – |
| Monthly debt and mortgage payments combined | $3,170 | $1,610 |
| Total interest charges | $105,897 | $332,688 |
In this example, you save $1,560 per month with the debt consolidation mortgage, but you will pay more in interest charges overall because the mortgage’s loan term is so long (30 years).
Note also that current tax laws don’t allow you to deduct mortgage interest on the portion of your loan used to pay off nonmortgage debt.
Types of debt consolidation mortgages
| How it works | Rate type | Best for | What to watch out for | |
|---|---|---|---|---|
| Cash-out refinance |
| Fixed | Homeowners with strong equity who want one fixed payment and the lowest possible rate | Resets the mortgage clock and puts your home at risk if you miss payments |
| Home equity loan |
| Fixed | Homeowners who don’t want to touch their current mortgage rate or term |
|
| HELOC |
| Variable | Ongoing or unpredictable debt payoff, not a single lump-sum payoff |
|
| Reverse mortgage |
| Fixed or variable | Homeowners who are at least 62 years old and plan to stay in the home long term |
|
If you choose a home equity loan or HELOC, you’ll have two mortgage payments to manage each month. Juggling two separate home loans with different payment amounts, interest rates and payoff schedules can be a downside if you’re looking to consolidate your debts and simplify your finances.
Debt consolidation mortgage programs
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Conventional cash-out refinance. If you have solid credit and steady employment history and income, you may qualify to borrow up to 80% of your home’s value with a conventional cash-out refinance.
- Additional costs: Because you can’t borrow more than 80% of your home’s value, you won’t pay monthly mortgage insurance (mortgage insurance protects your lender if you default on your loan).
-
FHA cash-out refinance. Borrowers with scores as low as 500 may qualify for a debt consolidation mortgage backed by the Federal Housing Administration (FHA). Like the conventional cash-out refinance, an FHA cash-out refinance caps you at borrowing 80% of your home’s value.
- Additional costs: You’ll pay two types of FHA mortgage insurance, including an upfront lump-sum premium of 1.75% of your loan amount. The second charge is an annual mortgage insurance premium that ranges between 0.15% and 0.75% of your loan amount, which is divided by 12 and added to your monthly mortgage payment.
-
VA cash-out refinance. Eligible military borrowers may be able to borrow up to 100% of their home’s value with a cash-out refi loan guaranteed by the U.S. Department of Veterans Affairs (VA).
- Additional costs: Although there’s no mortgage insurance requirement, VA borrowers may have to pay a VA funding fee between 2.15% and 3.30% of the loan amount, depending on whether they’ve used their benefits before.
- Home equity loans and HELOCs. There are no government-backed second mortgages, so if you’re interested in either of these options, you’ll need to seek out conventional loan lenders. You’ll typically need a good credit score and at least 15% home equity to qualify, and you won’t have any mortgage insurance to worry about.
- FHA reverse mortgage. If you’re 62 years or older with a lot of equity in your home (usually 50% or more), you may qualify for a home equity conversion mortgage (HECM), more commonly known as a “reverse mortgage.” Unlike a regular mortgage, your loan balance grows each month, meaning you lose equity in your home over time.
How to qualify for a debt consolidation mortgage refinance or second mortgage
Credit score minimum
- Conventional cash-out refinance: 680
- FHA cash-out refinance: 500
- VA cash-out refinance: No set minimum
- Home equity loans and HELOCs: 620 to 680
Debt-to-income (DTI) ratio maximum
- Conventional cash-out refinance: 45%
- FHA cash-out refinance: 43% to 50%
- VA cash-out refinance: No hard limit, but it may be harder to qualify with a DTI ratio above 41%
- Home equity loans and HELOCs: 43% to 50%
Home equity minimum
- Conventional and FHA cash-out refinance: You must have at least 20% equity remaining after the new loan [an 80% loan-to-value (LTV) ratio]
- VA cash-out refinance: VA loans allow up to a 100% LTV ratio for eligible borrowers, so you may not have to retain any home equity
- Home equity loans and HELOCs: At least 15% to 20% for most home equity loan and HELOC programs
Pros and cons of a debt consolidation mortgage
Pros
- Simplicity. You can simplify your finances by reducing the amount of debt you need to manage.
- Flexibility. You’ll have more room in your budget, which can help you avoid using credit accounts in the future.
- Savings. You can use the savings to pursue other goals. You could build up your emergency fund or apply the savings to your principal to pay down the balance faster.
- Credit score bump. Your credit scores may improve as a result of carrying less revolving debt.
Cons
- Increased mortgage debt. Your monthly mortgage payment may be higher, due to the larger loan amount.
- Interest costs. You’ll pay more in mortgage interest than you otherwise would have and typically pay a higher interest rate than you would on other refinance types.
- Risk to your home. You could lose your home to foreclosure if you can’t afford the new mortgage payments.
- Loan costs. You’ll usually pay between 2% and 5% of your loan amount toward closing costs.
- Tax limitations. You can’t deduct any mortgage interest that’s tied to your debt payoff.
Making the decision: Is a debt consolidation mortgage right for me?
A debt consolidation mortgage is a good idea if you’ll save more money overall than what it costs you to take out the loan.
Add up the interest and closing costs you’ll pay on the new mortgage, and compare that number to the interest you’d pay if you continued separately paying your existing nonmortgage debts and your current mortgage.
A debt consolidation mortgage may make sense if:
- You’re carrying high-interest credit card debt
- You have significant home equity
- You qualify for a much lower mortgage rate
- You have a plan to avoid accumulating new debt
Avoid one if:
- You’re only consolidating a small balance
- You expect to move soon
- Closing costs would erase your savings
- You’re already struggling to afford your mortgage
Alternatives to debt consolidation mortgages
| How it works | Rate type | Best for | What to watch out for | |
|---|---|---|---|---|
| Personal loan |
| Fixed | Renters or homeowners with little equity, smaller debt balances |
|
| Balance transfer credit card |
| A fixed promotional rate, then variable | Small balances payable within the promotional window |
|
| Debt consolidation programs |
| Varies | Those who don’t qualify for a debt consolidation mortgage due to low credit scores |
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