Cash Out Refinancing for Debt Consolidation

If you have lots of credit card debt, it might make sense to consolidate it to get a better interest rate and a single payment. If you own a home, you may be able to consolidate this debt by doing a cash out refinance.

What's a Cash Out Refinance
When you do a cash out refinance for debt consolidation, you are replacing your existing mortgage with a new one that is larger. You take the excess portion of the new mortgage out in cash, which you then use to pay off your debt.

To do a cash out refinance, you must have a significant amount of home equity, because most lenders only let you cash out equity in excess of 20 percent.

For example, if you have a home that's worth $150,000 and you owe $100,000 on your mortgage, you could get a new mortgage for $120,000 and use $20,000 to pay off debt.

Advantages
One big advantage to doing cash out refinance for debt consolidation is that you can get much lower interest rate. Most credit cards have interest rates of anywhere from 15 to 25 percent, while mortgage rates are around 4 percent.

Another advantage to consolidating debt with home equity is that you get one payment for all your debt. This makes it much easier to keep track of your debt and makes it less likely that you'll miss a payment or pay late.

Disadvantages
Cash out refinancing has a number of disadvantages. For one, the loans carry high fees. Just as with a mortgage you get when you buy a house, a refinance requires you to have the home appraised, and there are loan origination fees, documentation fees, fees for a credit check and other fees. These fees can reach into the thousands of dollars and cut into the money you are saving by consolidating debt.

Another disadvantage to doing a cash out refinance is that it prolongs the payoff period for your debt. Most mortgages are for 15 or 30 years, while you could easily pay off credit card debt in a few to several years.

A further disadvantage to doing a cash out refinance to consolidate debt is that by tying credit card or other debt to your home and increasing your mortgage amount, you are increasing the chance that you could default on your loan and lose your home.