How much lower should your interest rate be when you do a debt consolidation refinance?
We usually advise borrowers to refinance their mortgage if they can reduce their interest rate by at least .750% but our recommendation is different for a debt consolidation refinance because there are other loans involved. Rather than focusing on how much you can lower your mortgage rate by refinancing, you should focus on how much you can reduce your total monthly debt expenses and average interest rate.
If you are able to pay off higher cost debt and lower your mortgage rate, then a debt consolidation refinance usually makes financial sense. Depending on your loan terms, market conditions and other factors, credit cards, personal loans, home equity loans, home equity lines of credit (HELOC) and potentially student loans have higher interest rates than a mortgage.
Review How a Debt Consolidation Refinance Works
If you can use the equity in your home to pay off or down these loans you likely reduce your combined total debt expense and lower your average interest rate with a debt consolidation refinance. If you can also refinance into a lower mortgage rate then that is an ideal scenario.
For example, if your current mortgage rate is 5.0% and you have a $20,000 credit card balance that charges an interest rate of 15.0%, if you can refinance your existing mortgage and pay off your credit card balance with a new mortgage with a 4.5% rate, you lower both your total debt payments and average interest rate.
As a rule of thumb, with a debt consolidation refinance your new mortgage payment should allow you to recover your closing costs, or breakeven, within 30 months of closing your loan. If it takes longer than that to break even then the financial benefit may not be as compelling.
Use ourDEBT CONSOLIDATION REFINANCE CALCULATORto determine how much you can save
One potential option is to use a no cost mortgage when you refinance. With a no cost mortgage, you pay a higher interest rate but no closing costs. If you can lower your monthly debt payments without incurring costs when you refinance then you start saving money immediately.
It may also be financially feasible for you to pay a moderate amount of closing costs to refinance into a mortgage with a lower interest rate. With this approach, it takes some time to recover your closing costs but you likely save more money in the long run with a lower mortgage payment.
The table below shows mortgage refinance terms for leading lenders near you. We recommend that you compare refinance proposals from multiple lenders to find the best combination of mortgage rate and closing costs.
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In addition to potentially paying closing costs, another downside to a debt consolidation refinance is that you effectively extend the length of your original mortgage, unless you reduce your loan term.
For example, if you are 10 years into a 30 year mortgage and you refinance into a new 30 year mortgage, your original mortgage effectively becomes a 40 year loan. That means you pay interest for ten extra years, which is a long time and a lot of money, even if you lower your mortgage rate when you refinance.
Another factor to consider for a debt consolidation refinance is that using long term debt such as a mortgage to pay off shorter term debt such as a credit card bill or personal loan usually means you pay more in total interest expense, even if the loan has a higher interest rate. If your priority is to reduce your total monthly debt payments, then this is a less important factor but it is something to keep in mind.
Finally, if you have multiple loans and you are deciding which one to pay off first when you refinance, we recommend that you pay down the debt with the highest interest rate first. This approach saves you the most money in the long run.
Sources
"B2-1.3-03, What are acceptable uses for a cash-out refinance transaction?" Selling Guide: Fannie Mae Single Family. Fannie Mae, July 3 2019. Web.
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