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Is refinancing your mortgage to consolidate debt a good idea

If you have lots of high-interest debt, the monthly costs can overwhelm your budget. For some, the best road out of this situation is debt consolidation.

Debt consolidation pays off your high-interest debt with one, lower-interest loan to save on interest payments.

At today’s mortgage rates, a debt consolidation refinance or home equity loan can be a great way to save money. But this strategy can also be risky, so be sure to weigh the pros and cons before applying.

Debt consolidation works-how it works

Debt consolidation should make your debt payments more affordable each month. The goal is to pay off higher-interest debt with a lower-interest source of borrowing. And it’s generally good advice to pay as little interest as possible on the debt you hold.

High-interest debt typically comes from unsecured borrowing sources, like credit cards and personal loans. Debt consolidation is worth pursuing if you have steady and predictable income and want to make your monthly payments more affordable.

“Unsecured debt” means the lender has no collateral to recoup losses if you default on the debt. (Unlike a mortgage, which is “secured” by your home.)

It’s easy to get in over your head with multiple high-interest payments going to various lenders each month, especially when you have a lot of credit card debt.

Consolidating your debt by rolling your outstanding loan balances into a lower-interest mortgage can simplify matters and save you a lot of money.

What is a debt consolidation refinance

The goal of consolidating debt is to lower your monthly borrowing costs. And if you can roll all your high-interest debt into a low-rate mortgage refinance, it’s one of the best ways to save money on your total debt payments.

Cash-out refinance to pay off debt

Homeowners who want to consolidate debt often use a cash-out refinance. This kind of loan uses your home equity — that’s the part of your home’s value you have already paid off — to generate your “cash out.”

You’ll be increasing your mortgage balance to provide the cash. Then you can use the cash out for any purpose, such as making home improvements or even making a down payment on a second home.

Of course, you can also use the cash to consolidate your higher-interest-rate debt, creating lower monthly payments compared to your existing debt load. This strategy could leave only one remaining loan to pay off: your mortgage, which should have a low interest rate compared to your credit card accounts.

Focus on high interest rates first

Funds from a cash-out refinance can also be used to pay off other major obligations, like student loans or medical bills.

But if your goal is to become debt-free faster, then your higher-interest-rate debts should take priority. The money you save can later be applied toward paying down the principal on lower-interest debt like student loans or auto loans.

Remember, there are closing costs

Keep in mind that refinancing comes with closing costs, just like your original mortgage did. Look for an interest rate low enough that you’ll be able to recoup the upfront cost while saving on your external interest payments.

Your cash-out refinance costs can often be rolled into the loan amount, as long as there’s enough money left over to pay off the debts you were hoping to consolidate.

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