Using a Mortgage Refinance to Pay Off Debt

Should you refinance your mortgage to consolidate your debt?

As with any financial decision, you’ll want to do your research and consider all of your options. To determine if a cash-out mortgage refinance is best for you, ask yourself the following questions.

Will I be eligible for a mortgage refinance?

To be eligible for a mortgage refinance, you will need to meet the following criteria:

  • A credit score above 620 (580 for VA loans)
  • At least 20% of your home equity (excluding VA loans)
  • A debt-to-income ratio (DTI) of 50% or less
  • Enough money to cover closing costs
  • proof of income

Do I have enough equity?

Since you will be using the equity in your home for a cash refinance, you will need to have enough money to borrow while still retaining some of the equity in the home. This is a requirement of most mortgage lenders.

The amount of equity you leave in your home after refinancing matters because it affects your loan-to-value (LTV) ratio. Your LTV determines if you need private mortgage insurance, or PMI, which can cost you hundreds of dollars on your mortgage payment each month. If your LTV is over 80%, your lender may require you to pay for this insurance.

Recent changes mean that you also have trouble withdrawing money if you have an LTV above 80%. In most cases, only borrowers using a VA refinance loan will be able to withdraw money with LTVs above 80%. Indeed, the VA loan program allows qualified borrowers to use the equity in their home even if it is less than 20%. For VA loans specifically, you can cash out all of your existing equity if your credit score is 680 or better. Otherwise, you must have an LTV not exceeding 90%.

To see how a cash-out refinance might affect your LTV, follow the formulas below to calculate your numbers and compare.

To calculate your LTV before refinancing, divide your loan balance by the appraised value of your property. The formula looks like this:

Loan Balance / Appraised Property Value = LTV

Let’s say your home is worth $200,000 and your loan balance is $140,000. Your LTV would be 70%.

Property value = $200,000

Loan balance = $140,000

140,000 / 200,000 = 0.70

To determine your LTV amount with a cash refinance, simply add the amount of equity you wish to borrow to your current loan balance, then divide it by the appraised value of your property. The formula looks like this:

(Borrowed Equity + Current Loan Balance) / Appraised Property Value = LTV

Using the example above, we’ll add the $16,000 you would borrow to pay off your credit card debt. Your new loan balance would be $156,000 and your new LTV after your withdrawal rollover would be 78%.

Property value = $200,000

Loan balance = $140,000

Cash out amount borrowed = $16,000

New loan balance – $156,000

156,000 / 200,000 = 0.78

With an LTV of 78%, you can refinance in cash with enough equity remaining to avoid PMI.

Use this formula to calculate what your LTV would be after a refinance. If it’s over 80%, you might want to seriously consider whether removing that capital would give you enough money to meet your goals.

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