Taking out home equity to pay off debt

There are different ways that you can refinance your mortgage loan, and different tips and tricks for refinance options. Let’s look at a few of your options for lowering your monthly payment or taking cash out of your loan.

Cash-Out Refinances

A cash-out refinance should be your first consideration if you need to pay off a large debt. Before we go over what a cash-out refinance is, we need to talk about home equity.

Every time you make a payment on your home loan, you gain a bit of equity in your property. Equity refers to the percentage of your mortgage principal that you’ve paid off – it’s the part of your property that you own.

For example, you might have $100,000 remaining on a home loan that was originally worth $150,000. In this case, you have $50,000 worth of equity in your home. Once you make the final payment on your loan, you have 100% equity in your property.

How Cash-Out Refinances Work

You take equity out of your home in cash when you take a cash-out refinance. In exchange, your lender assigns you a higher principal balance. Your new, higher-balance loan amount replaces your old loan. From there, you make payments to your lender like you did on your last loan.

Let’s say that you have a $100,000 principal loan balance and you have $20,000 worth of debt to pay off. You take on a loan worth $120,000 when you take a cash-out refinance. The lender then gives you the difference ($20,000) in cash after closing.

How To Apply

The cash-out refinance process is similar to the process you went through when you got your original loan. You’ll apply with your lender, go through underwriting and get an appraisal. Once all your paperwork clears and your appraisal is complete, you’ll close and sign on your new loan. Your lender will then wire you your funds.

There are three important things to remember before you take a cash-out refinance loan:

• You’ll need to have enough equity in your property to qualify. Most lenders won’t allow you to take more than 80 – 90% of your home equity in cash.
• You may have to pay for private mortgage insurance again. Private mortgage insurance (PMI) is a special type of coverage that protects your lender if you default on your loan. Your lender will require you to have PMI on your loan if you have less than 20% equity after you refinance. Make sure you can afford the extra PMI payment.
• Be patient and wait for your funds. You won’t get your money immediately after closing. A lender needs to give you at least 3 days after you close in case you want to cancel your refinance. This means that your loan technically isn’t closed until after this period expires. Most people who take cash-out refinances see their money 3 – 5 business days after closing.

Rate And Term Refinances

It can be easy to fall into debt if you’re having trouble making your monthly mortgage payments. A rate-and-term refinance can help you divert more money toward your debt without changing your principal mortgage balance. This can help you better manage your finances and pay down debt.

As the name suggests, a rate-and-term refinance changes your loan term and/or interest rate. Taking a longer term or a lower interest rate will lower the amount you pay each month. In some rare circumstances, you can even refinance your rate or term without a new appraisal.

How Rate-And-Term Refinances Work

For example, let’s say that you have a $100,000 loan with a 4% interest rate and a 15-year term. Your monthly mortgage payment in this example is $739.69. Let’s say you refinance your loan to a 30-year term. Your monthly payment becomes $477.42. This leaves you with an extra $262 to put toward your debt without adding PMI or more money to your loan balance. Keep in mind that increasing your term will cause you to pay more in interest over time.

A rate-and-term refinance is faster than taking a cash-out refinance. You may be able to take out an FHA Streamline refinance if you have an FHA loan, or a VA Streamline refinance if you have a VA loan. Streamline refinances have less paperwork and looser requirements. Don’t qualify for a Streamline? You’ll follow largely the same process as a cash-out refinance:

• Compare lenders that offer rate-and-term refinances
• Look at current interest rates, lender availability and reviews
• Apply for a refinance and submit income paperwork to your lender
• Schedule an appraisal and let your lender underwrite your loan
• Close on your loan by attending a closing meeting, pay what you owe in closing costs and sign your new loan

Home Equity Line Of Credit

A home equity line of credit is not a refinance, but it can allow you to unlock equity in your home to be used to pay down debt. It’s important to note that Rocket Mortgage® does not offer HELOCs. A HELOC works like a credit card, and allows you to access up to 89% of your home equity to pay down debts.

Apply through a HELOC provider in your area. You’ll usually need at least 18 – 20% equity in your home, a debt-to-income ratio around 40% or less and a credit score of at least 620 to qualify for a HELOC or home equity loan.

How HELOCs Work

HELOCs are also revolving, which means that your credit “refills” after it’s paid off. For example, you may take out a HELOC with a $10,000 limit and spend $7,000 and still use another $3,000 on the line of credit.

Every HELOC starts with a “draw period.” During your draw period, you can spend on your loan up to the limit. The only thing you need to pay back each month is the interest that accumulates. Most draw periods last 5 – 10 years.

You enter the repayment period when the draw period closes. During repayment, you can no longer access your line of credit and you must pay your loan back in monthly installments. Keep in mind that you must make these payments on top of your regular monthly mortgage payments.

HELOCs are preferable to credit cards because they follow mortgage interest rates, which are lower than credit card rates. HELOCs allow access to your home’s equity without changing the terms of your original loan. You can also consider consolidating debt with a home equity loan, which offers you a lump sum of cash as a second mortgage. Rocket Mortgage® doesn't offer HELOCs, but we do offer home equity loans.

Can you use home equity to pay off debt?

Can I use a Heloc to consolidate debt?