The Debt Dilemma and Refinancing
A “cash-out” refinance, which allows homeowners to refinance their current mortgage and use some of their home equity to pay off other debts, is still one of the best ways to get out of debt fast, especially when interest rates are low. But homeowners with limited equity in their home may need to try other debt reduction strategies along with a home refinance.
As home values have dropped around the country, many homeowners find that while they once had 20% or 30% or more in home equity, they now may have just 15% or 10% or less. Refinancing is easiest for homeowners with extensive equity, but lenders are typically willing to approve a home refinance for up to 90% or even 95% of the home value, depending on the homeowners’ credit and debt-to-income ratio.
Refinancing and private mortgage insurance
Homeowners who refinance with a conventional lender and have less than 20% equity will need to pay private mortgage insurance (PMI), which will increase their monthly payments a little, especially if they have not been paying PMI on their current loan. Sometimes, though, the difference in the interest rate and the new terms of the home loan will make a refinance with PMI a better deal than keeping your current loan.
Debt management and refinancing
If your goal in refinancing is decreasing debt and you don’t have enough equity to take a cash-out refinance, you can still use a home refinance for debt management. By reducing your monthly housing payment, you will have increased income to spend on paying off your other debt more quickly. Just make sure you establish a budget and create a debt management plan you can follow easily.
Too much debt to refinance?
Homeowners with a too-high debt-to-income ratio to qualify for a refinance will need to do some fast work on their debt problems so they can apply again for a new home loan.
Here are some options suggested in a recent SmartMoney article for decreasing debt:
1. Put yourself on a strict budget. Increase your income, reduce your spending and pay down your highest interest rate debt first.
2. Ask for a loan from a family member or borrow from your 401(k). Just make sure you pay it back on time.
3. Consolidate your debt on a low-interest rate credit card to pay it off faster.
4. Work with a non-profit debt counselor (try NFCC.org) to develop a debt repayment plan and a budget. Beware, though, that signing on for a debt management program could reduce your credit score temporarily.
Remember that your goal is to refinance your home loan, so as you pay down your debt, apply again to see if you qualify for a mortgage refinance. The sooner your housing payments drop, the faster you can reach your goal of becoming debt-free.
