paying off high-interest debt with a cash-out refinance

Consider using the equity in your home as part of your debt-reduction strategy

On average, people in Ohio, Kentucky, and Indiana hold a bit more than $7,000 in credit card debt.¹ On the plus side, that’s better than most of the country. But that debt can be expensive, too. If you make only the minimum monthly payments, you’ll pay more than $9,000 in interest on top of the amount you originally spent.²

The high-interest rates you pay on most credit cards make reducing that debt a critical part of any household’s financial plan. If you’re struggling to pay down the balances on your credit cards, it’s a good idea to talk with a credit counselor who can help you look into options like debt consolidation. If you own your home, you may also be able to use your home equity to consolidate your debts through a cash-out refinance process. 

How a cash-out refinance works

When you refinance your mortgage, you take out a new loan to pay off your old loan. Mortgages typically have lower interest rates than other kinds of debt—and much lower rates than most credit cards charge. The average interest rate on a credit card was about 20% in 2018, while mortgage rates are considerably lower.²

If you’ve been making mortgage payments for a while and have some equity built up in your house, you can take out a new mortgage that covers the outstanding principal on your old mortgage plus enough additional cash to pay down your high-interest debt. In some cases, this strategy can lower your monthly payment and make it easier to pay down your debts. But it’s not always the right choice in all situations.

Disadvantages of using a cash-out refinance to pay off debt

Refinancing comes with closing costs and fees. Even if you can roll these costs into your loan, they could add thousands of dollars to the total. A cash-out refinance could also mean higher monthly house payments, since you’re increasing your mortgage balance by the amount of other debt you’re planning to pay off. 

Bear in mind that your house is collateral for a mortgage.  Should you stop making payments on your mortgage it could result in the lender foreclosing on your house.  Should you ever come into financial difficulty always call the lender in advance of missing payments to see what options they might have to help you. 

Another option for utilizing your home equity without refinancing is to take out a home equity loan or line of credit. With a home equity loan, you’ll get a lump sum upfront. With a home equity line of credit, you’ll have a source of funds you can draw on—and repay over a longer period.

How to decide what’s right for you

First, you’ll need to look at how much equity you have in your house. Most lenders will only let you borrow up to 80% of your home’s value without taking out private mortgage insurance, which adds to your monthly payment. Second, you’ll want to look at the projected monthly payment on your refinanced loan to make sure you can afford to pay it.

Finally, take a look at closing costs and fees, bearing in mind that you could be using that money to pay down your existing debt. To determine if a cash-out refinance is worth the cost, compare the closing costs with the overall interest savings on the debt you’re planning to pay off. If the interest savings doesn’t exceed the closing costs, it’s probably not a good idea to proceed. 

It never hurts to ask for help

Under the right circumstances, a cash-out refinance could be a good way to pay off high-interest debt. However, given the number of variables in play, it can be a difficult decision to make on your own—especially if you’re having trouble making payments. Fortunately, help is available. Debt counselors and credit counselors specialize in helping people find the right way to get out of debt, whether through repayment plans or various types of debt consolidation, including cash-out refinances.

You can find a list of credit counseling agencies at the U.S. Department of Justice’s website or contact a local member agency of the National Federation for Credit Counseling. You can also work with your local financial institution on credit consolidation counseling and options.