Cash Out for Debt Consolidation
Consumer credit card balances are on the rise, caused in part by a slow economy that is pushing people to use credit lines that provide temporary financial relief, but usually at a very high cost.
One potential way to alleviate the high cost of credit cards is a debt consolidation refinance or home equity loan, which combines multiple high interest debts into one lower monthly payment. Sounds simple enough, exept that you have to be a homeowner, and you need to have home equity and decent credit.
A debt consolidation loan is really another name for a cash out refinance or home equity loan. Unsecured credit cards, or other debts, are paid off using the equity in a home. A low fixed rate home loan reduces the monthly payment, and because a debt consolidation home loan is fully amortized, the debt will be gone at the end of the loan term. Also, converting debts to a secured home loan may save money because of possible tax deductible interest.
Another lesser known benefit of a consolidation loan is the elimination of daily compounded interest on credit cards. More interest charges accumulate on a compounded interest loan as opposed to a simple interest loan. Paying interest on the interest charges could be the end result if only the minimum payments are made.
Consider a simple loan example: An average rate of 15% on credit cards with a combined balance of $40,000 could have a monthly payment of about $560, over a 15 year term. A debt consolidation home loan with the same balance at 8% could have a payment of about $382 over the same term. A lower rate would of course result in more savings. Also, the home loan could be paid off in about half the time by applying the monthly savings to the payments.
When refinancing to consolidate debts, it should be noted that some lenders have an underwriting guideline called seasoning. Cash out can be limited under this guideline based on when home equity was taken out. Restrictions may apply if there was a cash out refinance done within the last 6 months to 1 year. Usually, this guideline applies if the new loan is over 75% of value.
The seasoning on a conventional home loan for debt consolidation may not be limited just to a previous refinance. If there was a home equity loan, second mortgage, or line of credit, within the last 6 months to 1 year before refinancing, the new home loan could also be subject to cash limitations.
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