Consolidation

You can use cash-out refinancing to consolidate debt.

Cash-out refinancing can help you consolidate debt. It is a useful tool, but it must be used in conjunction with controlling your spending.

What is cash-out refinancing?
It is the process of taking out a new mortgage with a larger principal than your current mortgage. The difference in principal is paid to you as cash, which you can use for almost any purpose, including debt consolidation.

How does it work?
Cash-out refinancing is based on your home equity, which is the part of the home that you actually own. For example, if you have a home worth $250,000, and you owe $200,000 on the mortgage, you have $50,000 worth of equity in the home. If you refinance, that $50,000 is available for you to use (depending on your lender’s rules).

What can you use the cash for?
You can use the cash in almost any way you want. One wise way to use it is to consolidate your debt. If you have high-interest credit card debt, you can usually get a much lower interest rate by using your home to secure the loan. For example, if you have $20,000 in credit card debt, you can use cash-out refinancing on your home and increase your principal by that same mount: $20,000. At closing, you get that $20,000 in cash and can use it to immediately pay off your credit card debt.

At this point, the debt is now wrapped up into your mortgage, but that can be advantageous to you. Instead of paying an exorbitant interest rate — some credit cards are as high as 18 percent — that is not tax deductible, you can pay a much lower rate – such as 6 percent — and get tax benefits since the debt is tied to your mortgage.

Cash-out refinancing does not necessarily raise your monthly mortgage payment, although it certainly is possible that you could end up with higher monthly payments after refinancing in some situations. Your overall debt payment will be less, though, since you are not paying high interest to a credit card company.

What should I know first?
If you are considering cash-out refinancing, you need to be aware it only makes sense if you couple it with financial restraint. If you do not curtail your spending, cash-out refinancing can be a foolish move. If you use the money and then wind up running up more credit card debt later, you could find yourself in serious financial trouble: A larger debt on your mortgage plus even more credit card debt. Also, because the debt is now tied to your mortgage, you could lose your house if you fail to repay the debt.

Despite its risks, cash-out refinancing can still be a smart option if you need to get out from under high-interest debt, and you change your spending habits.

Debt Consolidation

Simply put, debt consolidation is the process of combining multiple debts into a single one. These debts are normally borrowed at high interest rates, so the idea for most people is to consolidate them at a lower interest rate. This lowers the cost of borrowing, and adds the extra convenience of dealing with fewer creditors and individual bills each month.

Debt consolidation works best when you take a number of unsecured loans and combine them into one secured one, which usually means having collateral (like a house) to put up. A secured loan will normally carry lower interest rates, which offer the most savings for the consolidator. That said, there are programs available for people who do not own a home or other assets to qualify for a secured loan, though the savings may not be as large because the interest on the consolidated loan may be higher.

1. While debt consolidation is something you can do by yourself, there are companies that typically offer a full debt management program including consolidation, and most consumers elect to utilize such a program rather than take the task on alone.
2. While some “debt consolidation” companies can in fact reduce your debt burden by reducing what’s owed to your creditors – this is technically debt settlement or debt negotiation, a very different process.

If you’re currently paying high interest on more than one account, whether they are credit cards, medical bills or just about any other type of unsecured loan; debt consolidation is likely a good option for you provided you qualify for a lower-interest loan. The better interest rates will allow you to reduce your total payments and pay off your debts much faster and with less hassle.

Here is some debt consolidation advice that has stood the test of time. Let’s say that you’re $6,000 in debt to credit card companies, utilities suppliers, and friends and family, and you only bring in around $2,000 a month via your income stream. Given that your debts alone require a $125 worth of interest servicing per month, you need to work assiduously to reduce your balances and get your financial plan in order.

Experts at giving debt consolidation advice instruct their clients to consider a host of tactics in situations like this. You can negotiate with your creditors or your utility company to lengthen the term of your loan arrangements, reduce your monthly charges, or even potentially excuse some of the fees or service charges to help you get your life in order. You may also write creditors letters requesting debt assistance. Assuming that you make a good effort to meet them halfway, you may be able to knock down your debt by 20 percent to 30 percent.

Of course, to consolidate your debt this way, you generally need to present a lump sum of 70 percent to 80 percent worth of your loan upfront, and there are many legal pitfalls here. Get professional debt consolidation advice form an attorney or an accountant if you go this route, and check your credit reports to make sure that your cleared history shows up in the bureaus’ files on you.

Another time-tested piece of debt consolidation advice involves tackling one major issue at a time. If you attempt to service all of your debt simultaneously with a limited amount of funds, you could stretch yourself too thin, leaving you without enough money to buy month-to-month essentials. This in turn can stress you psychologically and ultimately lead to yet another spiral of spend and owe.

Instead, figure out how to deal with one creditor at a time. Resolving each issue will reduce your paperwork and lower the amount of red flags you are sending out to other creditors. Whether you want to tackle the big credit card debt that’s been brewing for years or your urgent utility bill debt is up to you, your family, and your debt management counselor.

A final piece of debt consolidation advice is axiomatic and in many ways very intuitive. Create the conditions for budgetary health by checking in with your spending and savings plan at least once a month. This way, you won’t be caught off guard by interest rate charges, you’ll know precisely where your money is going, and you’ll be able to catch inaccuracies, errors, or fraudulent charges on your accounts before they metastasize into larger problems.