Does it Make Sense to Use My Home to Reduce Revolving and Installment Debt?

May 6, 2022

Knowing the best way to go about revolving versus installment debt reduction can be difficult. The answer to whether you should pay off my revolving or installment debt first is not necessarily “one-size-fits-all.” However, it may be beneficial to explore reducing revolving or installment debt using equity, or otherwise leveraging your home, as it may reduce exposure to higher long-term interest rates and other debt-compounding factors.

Homeowners can often achieve debt reduction by refinancing their existing mortgage, using cash-out refinancing strategies, or taking out a home equity loan. Read on to learn more about how these measures can help in the debt reduction process.

How to Refinance an Existing Mortgage

One way you can use their home to help with debt reduction and revolving or installment debt is by refinancing an existing mortgage. Mortgage interest rates are still near all-time lows, making mortgage refinancing options look appealing right now. Refinancing a mortgage at a lower rate will help reduce monthly obligations. In turn, the money saved every month through a lower rate can be used to pay off other debt, such as high-interest credit card balances.

The Pros and Cons of Refinancing an Existing Mortgage

Pros:

• Reducing the interest rate will save money over the life of the loan, freeing up vital cash in the process.
• Refinancing an existing mortgage can extend the repayment schedule, helping further reduce monthly payments.

Cons:

• Refinancing the mortgage will cost money, as there can be closing costs, points and origination fees, appraisals, and surveys.
• Refinancing to extend the repayment time could cause the borrower to spend additional years in debt to pay off the mortgage.

Cash-Out Refinancing

Another strategy that can be utilized for debt reduction and lower revolving and installment debt is cash-out refinancing. Cash-out refinancing requires borrowers to already have sufficient equity in their homes. Essentially, they are taking out a larger mortgage that pays off the old one and leaves them with cash at closing that can be used to pay off other bills. To calculate the equity of a home, simply take the difference between the market value of the property and how much is owed. The First Western Trust team can help take the guesswork out of determining if this is a viable option for your situation.

The Pros and Cons of Cash-Out Refinancing

Pros:

• Borrowers save money by reducing their interest rates.
• The number of payments borrowers need to make each month is lowered.
• Mortgage interest can be deducted from income taxes, meaning borrowers turn non-deductible debt into deductible debt, which could help them lower their federal tax payments.
• Borrowers may be able to lower their monthly payments by combining all their debts, which can mean saving more money and paying off their mortgage sooner.

Cons:

• Financial situations could get worse if borrowers continue to habitually overspend after rolling their debts into a new mortgage.
• Refinancing has a percentage cost based on the loans’ principal.
• Borrowers will own less of their home when they cash out their equity.
• Borrowers will tie an asset to their debt when they turn their credit card debt into a secured debt through their mortgage.
• Borrowers could end up spending more in total interest costs over the course of their loan, depending on how long their new repayment plan lasts.

Home Equity Loans

An additional strategy that can be used to help with debt reduction and lowering revolving and installment debt is to apply for a home equity loan. Home equity loans are sometimes referred to as second mortgages. If a borrower already has significant equity in their home, they can then use it as collateral to secure an additional fixed-rate loan which can be used to help pay off their other debts.

The Pros and Cons of Home Equity Loans

Pros:

• Home Equity loans offer tax benefits.
• The interest rates for home equity loans are generally lower than those for an unsecured loan or credit card.

Cons:

A home equity loan creates a lien against a borrower’s property, which reduces their equity in the home as the owner.
If a borrower can’t make their loan payments for whatever reason, they risk defaulting, which could lead to foreclosure, in which they would lose their home.

The Bottom Line

Ultimately, using your home to help lower revolving and installment debt may be a viable option, and one of the three strategies above can be beneficial to achieving it if it makes sense as part of a border financial well-being strategy. However, it’s best to evaluate every situation on a case-by-case basis to determine which option will be more useful when it comes to reducing both revolving and installment debt for the long term. The team at First Western Trust will be more than happy to assist you in evaluating the right option for your situation.