If you have a bunch of high interest debt but have equity in your house, you might be able to create a do-it-yourself debt consolidation loan to refinance. Refinancing your house is a process of getting a new mortgage to replace the old one. If your house is worth substantially more than what you all on it, you may be able to get the second mortgage for significantly more than the first mortgage is paying off.
Let’s say you own $100,000 on your house. If your house is worth $150,000, you could reasonably expect to get a loan for $120,000 to pay off the $100,000 mortgage. This would leave you with $20,000 in cash. Assuming your mortgage rate is 5% or 6%, $20,000 to pay off credit card debt at 29% might be a very wise financial move.
However, if you have substantial credit card debt you may have a difficult time qualifying for refinancing the first place. Still, it might not be a bad avenue to explore given the potential gains.
Mortgage insurance
When looking at a refinance you must consider mortgage insurance or PMI. mortgage insurance is an additional fee you pay on top of your mortgage payment that allows the bank to buy insurance in case you default. Mortgage insurance is usually only required when the bank feels a default would leave them in a poor financial situation with regards to the value of your house. So if the amount you owe on your house is close to its value, the bank will require mortgage insurance. That way if you stop paying and destroyed the house when they evict you, they are protected from a loss due to a lower selling price.
Normally mortgage insurance is required when you have less than 20% equity in your home. This means if you buy a home for $100,000, borrowing any more than $80,000 will result in a need to pay mortgage insurance.
The mortgage insurance requirement may negate any benefit of consolidating high interest debt into your mortgage.
Refinance process
The refinance process is very similar to the process of getting a mortgage in the first place. It requires an appraisal, a credit check and approval by underwriting. Since the recent financial debacle there are a host of new rules related to refinancing. In general they are designed to prevent people from borrowing more against the house than it is actually worth.
For example, you must own your house for at least six months before doing a refinance that involves taking cash out or valuing your house at a price higher than the original appraisal or the price you paid (whichever is lower). If you paid cash for your house, the waiting period is 12 months.
Another recent change is the need for multiple appraisals. If the appraisal for refinance shows that the value of the house has increased more than 10% of the original price, a secondary appraisal is usually required. This is done to lower the bank’s risk that an individual appraisal might come in higher than the actual value of the house.
Qualifying for refinance
As mentioned before, if you have substantial credit card debt you may find it difficult to qualify for refinancing the first place. Banks will look at the amount of your monthly payment on your credit card and subtract that from the amount that they say you could afford to pay on your mortgage. Your credit report will also be impacted by the ratio of credit card debt to possible credit card debt. For example, if your credit card has a $10,000 limit and you owed $9500 this would probably hurt your credit rating. If you had a $100,000 limit, it is likely to make very little impact.
Final thoughts on refinance consolidation
Debt consolidation through refinancing your mortgage can be very useful strategy to lower the amount of money you pay in interest on credit card and other expensive debt. It may not work for everyone, but is worth checking into particularly because interest rates are so low on mortgages right now.
A word of caution. All mortgages are not equal. Some require significant expense in the form of closing fees. Make sure you understand the entire cost of a mortgage before attempting a refinance.
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