Refinancing and Consolidating Debt

March 8, 2020 | by Jacob Hamilton

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If you have a significant amount of debt, it can feel overwhelming to try to keep track of it all. Having debt is stressful enough, and if there’s anything you can do to make it easier, you should consider it. One common option is to refinance to consolidate debt. In this blog post, we break down everything you need to know about refinancing and consolidating debts so you can better understand if it’s the right option for you.

What Is Debt Consolidation?

Debt consolidation is a type of debt refinancing. With debt consolidation, an individual takes out one loan to pay off many others. As the new, larger loan brings together several small loans, the process is known as “consolidating” debt.

Typically, this consolidated loan has a lower interest rate than some of the other existing loans. Additionally, the individual now only has to worry about one monthly loan payment versus making many different payments, which can be challenging to track.

What Does It Mean to Refinance to Consolidate Debt?

When you refinance to consolidate debt, you’re refinancing your mortgage to consolidate your other debts. First, you will need to examine all your current loans and bills and their interest rates. If you choose to proceed with refinancing to consolidate debt, you’ll want to find an interest rate that is an average or toward the lower end of all your rates. Mortgage rates are typically much lower than credit card or personal loan rates, so this shouldn’t be an issue.

Next, you need to total all your outstanding loans. You will need to be approved for mortgage refinancing and find out if you can get enough to cover all your loans. You can then use this money to pay off all your small loans and focus on the new, single loan payment.

Often, the best way to consolidate your debt is by refinancing your mortgage. The creditor will require security on their end, and if you have a lot of debt, your property may be the only means of providing sufficient capital for them.

Potential Pros of a Debt Consolidation Refinance

You Can Get a Lower Interest Rate

Often, when you refinance to consolidate debt, you can receive a lower interest rate than you currently have on most of your loans. The lender is receiving a much larger loan payment from you, so they can still make a significant amount of interest. This allows them to offer you a lower interest rate.

For example, let’s say you previously had two loans at $10,000 each and an interest rate of 22 percent for five years with a monthly payment of $277. Each creditor would earn $6,571 in interest off you for the lifetime of the loan. Since you have two loans, you’re actually paying $13,142 in interest between the two creditors.

In comparison, let’s say your new creditor took your $20,000 debt and gave you an interest rate of 15 percent for five years, with a monthly payment of $476. The creditor would earn $8,548 off of you, so they’re still earning more individually (compared to the $6,571 the other creditors earned). However, you’re paying almost 35 percent less in interest overall, thanks to your new interest rate.

Additionally, when you consolidate your loan, you can switch to a fixed interest rate. A fixed interest rate will allow you to know what your monthly payment will be, no questions. This enables you to plan better. It also reduces the risk of your interest rate spiking due to unforeseen economic influences.

It Will Be Easier to Manage Payments

You’ll be switching from multiple loans with varying amounts and different due dates to one straightforward payment. This will help you keep track of things and ensure you are never late or never miss a payment. Missing or making late payments on loans can significantly impact your credit score and can sometimes incur fees.

Additionally, having only one loan will allow you to track your progress more clearly. Previously, all of your small loans may have been at different points in their debt repayment period, making your end date harder to visualize.

Potential Cons of a Debt Consolidation Refinance

Your Home Will Be on the Line

When you refinance, you’re likely taking your unsecured loans and merging them into one secured loan. Unsecured debt has no collateral backing, while secured debt requires the borrower to put up assets as security.

If you choose to refinance your mortgage to consolidate debt, you’ll be putting your home on the line. If you’re unable to make your monthly payments, the creditor has the right to take possession of your home and sell it to recoup their losses.

Your Loan Term Will Reset

It’s important to understand that a mortgage refinance will reset your loan term. So, if you were 15 years into a 30-year mortgage, the loan will reset to the full 30 years again. This means you’re paying the interest for an extended period of time. In this case, you’ve extended your interest payments from 15 years back to another 30 years.

You need to consider if your short-term savings on your higher-interest debt is worth paying interest for a more extended period on your mortgage.

4 Tips for Refinancing to Consolidate Debt

Here are four concrete tips when it comes to a refinance to consolidate debt plan.

1. Remember Closing Costs

Refinancing is like signing a new mortgage. As a result, it comes with closing costs. On average, closing costs can range anywhere from one to five percent of the total loan. If you have a $300,000 mortgage, closing costs can be between $3,000 and $15,000.

You will need to ensure your interest rate is low enough that you can recoup these up-front costs and still save on your external interest payments.

2. Do Your Own Research

It’s in our nature to trust that banks have the best intentions for their customers. Unfortunately, that’s not always the case. One tactic to watch out for is your bank over-appraising your home. A bank might do this so it can write you a loan on it and put you underwater on the mortgage.

Always conduct your own research and find out what your home is really worth.

3. Consider Other Options

Mortgage refinancing for debt consolidation isn’t for everyone. The more you know, the more likely it is you can make the best decision for your situation. Consider that there are other options you can turn to, such as home equity lines of credit and home equity loans, personal loan debt consolidation and credit card balance transfers.

Look at all your options and see what will have the least negative impact on both your current and future finances.

4. Decide on a Plan for the Future

After consolidating your debt, there may be a false sense that you’re free. It’s essential to stay on top of your loan and be aware that you still have a lot to pay off—and you want to ensure you don’t run up more debt in the future.

Have an honest conversation about how you got into this much debt, and make a plan to maintain good money practices in the future.

Will a Debt Consolidation Refinance Affect My Credit?

Applying for a debt consolidation refinance loan shouldn’t harm your credit score. Yes, you’re planning on taking out another loan, but you’ll be paying off all your outstanding debts simultaneously. Additionally, if you make on-time and regular payments on your refinance loan, your credit score should actually improve. For more information about what does and does not affect your credit, visit CreditRepair.com.

Generally speaking, most people should only consider a mortgage refinancing loan for good reasons. A plan to refinance to consolidate debt is the right choice for some people. It’s essential to do your research, understand the potential consequences and ask for professional advice before making a decision.

Refinancing & Consolidating Your Debt

If your debts have stacked up to the point where you feel like you're drowning, you might be looking for ways to make life a little simpler. One avenue to consider is refinancing your mortgage. A carefully thought out and executed refinance can save you hundreds, if not thousands, of dollars, and can indeed make life simpler, by consolidating many unsecured debts into one lower, secured monthly loan payment.

Sound good? Here is a breakdown of the advantages and disadvantages of refinancing your mortgage in order to consolidate your other debts.

The Possible Advantage of Refinancing

You can usually acquire a lower interest rate than what you are paying on your current debts, especially if these are credit card debts.

Another advantage is the possibility of switching from an adjustable interest rate to a lower fixed interest rate. Something else to consider is eliminating the chore of keeping track of all those monthly payments by combining them into a single simpler monthly payment.

Applying for a debt consolidation refinance loan should not harm your credit report or your credit score because even though you are taking out another loan, you will also be paying off some or all outstanding debts, and if you pay your remaining refinance loan faithfully, your credit should actually improve.

A debt consolidation refinance loan is still a mortgage loan, and thus is eligible for tax deductions. This is something no credit card debt or high interest auto loan offers.

Because you will acquire a lower interest rate on your refinance loan, you will end up paying less every month than you are right now with all those outstanding debts, plus you will pay off your debt sooner.

You could conceivably take the cash difference every month (the money you are saving with your lower interest refinance loan) and put it in an IRA for your retirement, towards your children's college educations or into an emergency fund.

Possible Disadvantages of Refinancing

You are putting your home up as collateral on this loan. If you do not make your monthly refinance loan payments, the lender can take your home away from you and sell it in order to recoup financial losses.

If you do not research beforehand, and immediately choose to go with either your present lender or whoever offers the lowest interest rate, you could get stuck paying high refinancing fees that may result in it taking years for you to break even.

A Few Things to Keep In Mind

Each time you apply for a consolidation loan, the lender will likely run your credit report. That will usually mean that an inquiry will be reported to the credit bureau(s). Inquiries take two or more years to naturally drop off your report, and according to the FICO website, inquiries are factored into the "New Credit" category which is 10% of your total FICO score.

You should only consider debt consolidation through refinancing if the long-term savings outweigh the initial output. Divide the cost of the refinance by your monthly savings. The sum you come up with is the number of months you need to remain in your current home in order to make this loan worthwhile.


Jacob Hamilton

Jacob Hamilton

GM of CreditRepair.com

With his master's degree from the University of Phoenix, Jacob has been working as the General Manager for CreditRepair.com for 2 years. Jacob is passionate about consumer finances and doing everything he can to make credit repair accessible....

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