If you've accumulated some high-interest debt but have equity in your home, a home equity loan or line of credit (HELOC) can be tempting. But should you really fight debt with debt?

Debt weighs heavily on your mind—and your budget. And while there are always heroic ways to pay it off outright, you may see your progress plateau after having children or any other big life change. In that case, consolidating high-interest debt into a lower-interest loan may be your best option.

In this article, we’ll look at how refinancing your mortgage could be a smart way to consolidate your debt.

How much debt do you have?

Let’s say you’re carrying $40,000 in debt in various forms—a personal loan, credit cards, school loans, car title loans, and other debts. The interest rates on these loans are all quite high; you’re shelling out more than $1,000 a month in interest, yet still making no progress on paying most of it off.

On the plus side, the house you bought for $100,000 10 years ago with a 30-year fixed-rate mortgage is now worth $175,000. You put 20% down at the time you bought the house, and now owe approximately $70,000 on it. Therefore, the total equity in your home is $125,000 (minus the $12,000 to $15,000 in realtor’s fees and transfer taxes you would incur in selling). This amount of money would pay off all of your debt.

The question: Should you refinance your house with a mortgage to pay this debt off? Should you go further and refinance the entire loan into a lower interest rate, lowering your monthly payment and extracting money beyond what is needed to pay your debt? Here are the steps you should take to determine the best financial path to take in this situation.

What are the interest rates on your current debt?

Interest rates on debt vary widely. There are two main drivers determining the interest rates on your debt: your credit score, and whether the debt is secured or unsecured. Loans that are attached to collateral (secured) generally have far lower interest rates than loans that are not.

For example, mortgages and car loans generally have rates that are between 2% and 4% , and less than 7%, respectively. Conversely, an unsecured personal loan from a bank or a credit card could have an interest rate of up to 25-30%. Generally, the lower your credit score, the higher your interest rates will be for any type of loan.

In our $40,000 scenario, $20,000 is spread across two credit cards with interest rates of 19.99%; $10,000 is for a school loan at 5.75%; and the other $10,000 is for a car loan with an interest rate at 3.99%.

What debt should you refinance?

Here’s the most important consideration: If you lose your job or take out a refinancing loan that you can’t afford, you are much more likely to lose your house than if you were to declare bankruptcy due to excessive personal debt. This is because, in most states, the law allows one to protect some equity in a primary residence when discharging debt in bankruptcy.

As a rule, don’t refinance debt that can be discharged in bankruptcy into a mortgage you can’t afford. Your housing expenses should not be more than 30% of your total post-tax income. If you make $3,000 a month after taxes, you should not have a mortgage that’s more than $1,000 a month. Your limit may even be less depending on your other fixed expenses.

Refinancing out of $20,000 of credit card debt at 19.99% interest is a bit of a no-brainer. But what about student loan debt? This is probably the trickiest question.

At today’s interest rates, school loans have an interest rate about 3% above that of a typical mortgage. On the other hand, if you ever needed to defer paying student loan debt due to financial hardship, this is easier to do than it is to avoid paying a mortgage. Overall, you might wish to consider refinancing some student loan debt into a mortgage so that the student loan doesn’t also have a 20-30 year payoff, but keep a certain, fairly low student loan balance after the refinancing (say, less than $15,000) that can be paid off with extra payments within a few years.

The bottom line: prioritize higher interest debt.

What type of mortgage should you refinance into?

Banks offer a wide variety of mortgage products. Here is a quick summation of some of them, according to some quick comparison points:

15-year versus 30-year mortgage

Generally, 15-year mortgages will have interest rates that are about one-half to one percent lower than will 30-year mortgages, as the quicker repayment period reduces the risk to the bank. However, as the time period of the loan is compressed, the overall payment will usually be substantially higher. By and large, 15-year loans should only be taken out if (a) you can afford the higher payment; (b) you likely won’t be employed at the end of the 30-year term; and (c) the extra money being tied up isn’t needed for something else.

Adjustable rate versus fixed-rate mortgages

Adjustable rate mortgages are also known as “5/1 ARMs” or “7/1 ARMs”. The rates usually adjust once a year by a certain amount tied to a given fixed index rate. ARMs usually carry a lower initial interest rate and payment than a fixed-rate mortgage, but with considerably higher attendant risk. Overall, these are not a good bet if interest rates are historically low and likely to rise, or if there is a general inflationary environment, meaning higher than four-five percent a year. Currently, a fixed-rate mortgage at, say, 3.5% or 3.75% is probably a better bet than an ARM because today’s interest rates are historically low.

Home equity line of credit (HELOC)

Instead of refinancing, you can apply for a home equity line of credit. The money will be there to draw on whenever you need it. Figure offers HELOCs of up to $250,000, with interest rates starting at 3.49%¹. You’ll pay a one-time origination fee to access as much of the funds as you need, however often you need them.

With Figure, the entire application process is online. You can apply from the comfort of your home and get approval within five minutes. Best of all, you’ll have access to your funds only five business days after closing.

Cash-out refinance

Another option is a cash-out refinance, which lets you refinance your home while also taking some extra out in cash. If your house has decent equity, you can do this without increasing your monthly mortgage payment.

Figure also offers competitive rates on refinances, with the option of taking out up to $500,000 in cash, depending on the amount you qualify for. They even offer cash-out jumbo refinancing of up to $1,000,000, with a cash-out max of $500,000. 

Best of all, once approved, Figure’s turnaround process is quick, with cash often available in your bank account in a matter of weeks, not months.

Terms and conditions apply. Visit Figure for details. Figure Lending LLC is an equal opportunity lender. NMLS #1717824

Summary

So you’ve gone through all the calculations above. You can afford a $75,000 mortgage to clear your debt and keep a little extra “change” according to the initial scenario. Your credit score is good enough to get a good interest rate.

Overall, a plan to consolidate debt with a refinanced mortgage seems like a good idea. Here are some final questions to ask yourself before you start shopping around for a mortgage.

  • How much is your home actually worth? In some markets, housing prices have plunged more than 50% in the last 10 years. Banks sometimes over-appraise houses to write loans on them; do your own research if you are refinancing to make sure your bank isn’t paying off your debt in exchange for putting you underwater on a mortgage.
  • Do you expect to have to relocate? Refinancing if you think you will have to move for some reason in the next two to four years is usually a bad idea outside of very active housing markets, as it can be tough to sell a house quickly in many areas of the country.
  • How do you avoid running up credit card debt again? This is the biggest challenge. What if you refinance, then get more credit cards and put yourself back where you started? The best way to avoid this is to set a budget. Get a sense of how much disposable income you actually have; most people who are in debt in spite of being employed and healthy don’t accurately forecast how much their lives cost.

Do you have any stories about successful refinancing that helped free you from excessive debt? Share your tips in the comments.

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¹Figure’s APRs start at 3.49% for the most qualified applicants and are higher for other applicants. For example, for a borrower with a CLTV of 45% and a credit score of 800, a five-year Figure Home Equity Line with an initial draw amount of $50,000 would have a fixed annual percentage rate (APR) of 3.49% and a 4.99% origination fee. Your total loan amount would be $52,495. You will be responsible for an origination fee of up to 4.99% of your initial draw, depending on the state in which your property is located and your credit profile. Your actual rate will depend on many factors such as your credit, combined loan to value ratio, loan term and occupancy status. The advertised rate of 3.49% includes a combined discount of 0.75% for opting into a Quorum Membership (0.50%) and enrolling in autopay (0.25%). APRs start at 4.24% for customers that do not opt in to autopay or apply to become a Quorum member. Property insurance is required as a condition of the loan and flood insurance may be required if your property is located in a flood zone.

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About the author

Elizabeth Spencer
Total Articles: 75
Elizabeth Helen Spencer is a personal finance and travel writer based in the Philadelphia area. She holds an MFA in Creative Writing and still nurses a secret fiction writing habit on the side. When not writing for work or pleasure, she loves to sweat it out in a hot yoga class and find new books to read. Elizabeth lives with her husband and two children and has reached the conclusion that "having it all" is a myth.

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