Under the right circumstances, cash-out refinancing can be a great way to consolidate your debt. However, you do need to be sure that it is right for you.
What is cash-out refinancing?
Cash-out refinancing is the act of taking out a new mortgage with a larger principal than your current mortgage. Its purpose is not necessarily to get a lower interest rate, but instead to turn home equity into cash.
Home equity is the part of the home that you actually own. Over the life of your loan, you build up home equity through paying toward the principal of the mortgage or through the appreciation of your home. Through cash-out refinancing, the equity becomes available to you to use.
For example, if you owe $150,000 on a $200,000 mortgage, you can refinance your mortgage so that you owe more principal. The difference is then made available to you in cash. In this case, you can refinance so that $50,000 is available for you to use (depending on the amount your lender lets you borrow).
Does cash-out refinancing make sense for you?
If you have high interest debt that you want to pay off and you are able to rein in your spending, the answer may be yes. You may be able to use cash-out refinancing to get a much lower interest mortgage with a larger principal, where the difference is enough to pay off that credit card debt. Used wisely, that can be a smart move. Not only will you save money on interest, chances are your total monthly debt payments will be less. Instead of paying high interest rates to a credit card company, you pay a lower rate to your mortgage company. There is a good chance that your monthly mortgage payment will not even go up, and interest paid on mortgages is often tax deductible.
Are there any risks?
If you are considering cash-out refinancing to consolidate your debt, it is important to understand that you will have to control your spending. It does not make sense to refinance your home and increase your principal to pay off your creditors, only to amass more debt. It is imperative to your financial health to exert self-control if you choose this option. With cash-out refinancing, your debt is tied to your home. If you run up so much debt that you cannot make your mortgage payment, you stand the chance of losing your house. Be sure you can control your spending before you make this choice.
If you can control your spending and just need an injection of cash to get out of debt, then cash-out refinancing can be a smart move. Carefully look at your situation and weigh the pros and cons to determine if this option is right for you.