Using a Mortgage Refinance to Pay Off Debt

Should You Refinance Your Mortgage to Consolidate Debt?

As with any financial decision, you should do your research and consider all of your options. Ask yourself the following questions as you determine if a payout mortgage refinance is best for you.

Am I eligible for a mortgage refinance?

To qualify for a mortgage refinance, you must meet the following criteria:

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

Do I have enough equity?

Since you’re using the equity in your home for a payout refinance, you need to have enough credit while keeping some equity in the home. This is a requirement of most mortgage lenders.

The amount of equity you leave in your home after refinancing is important because it affects your loan-to-value (LTV) ratio. Your LTV determines whether you need personal mortgage insurance, or PMI, which can cost you hundreds in mortgage payments each month. If your LTV is greater than 80%, your lender may require you to pay for this insurance.

The recent changes mean that you will also have a hard time withdrawing if you have an LTV of more than 80%. In most cases, only borrowers using a VA cashout refinance loan can withdraw cash with LTVs greater than 80%. This is because the VA loan program allows qualified borrowers to use the equity in their homes even if it is less than 20%. Specifically for VA loans, you can cash out all of your existing equity if your credit score is 680 or better. Otherwise, you must have an LTV of no more than 90%.

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

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

Loan Balance / Estimated Property Value = LTV

Let’s say your house 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 find out what your LTV would be on a payout refinance, simply add the amount of equity you wish to borrow to your current loan balance, then divide by the estimated value of your property. The formula looks like this:

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

Using the example above, we 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 payout refinance would be 78%.

Property value = $200,000

Loan Balance = $140,000

Borrowed payout amount = $16,000

New Loan Balance – $156,000

156,000 / 200,000 = 0.78

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

Use this formula to calculate what your LTV would be after a refinance. If it’s above 80%, you should seriously consider whether raising that equity would make you enough money to meet your goals.

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