Debt Consolidation BasicsCash-out refinance or a second mortgage can be used for debt consolidation if that becomes necessary. If the monthly payments for your various debts are getting too much for you, and you have equity on your home, it makes sense to use that to pay the debts off. The interest you are paying on loans and other debts is much greater than what you gain with tied up equity.

The question is whether it is better to use a second mortgage or cash-out refinance. The former is a loan taken out using your equity as collateral, while the second involves refinancing your mortgage for a higher amount. This should be sufficient to clear your current mortgage and also pay off your debts. Your monthly payment will increase, but should overall be much less than your old mortgage plus all your debt payments.

Which is Cheaper for Debt Consolidation?

You obviously want to make your choice based upon which debt consolidation option costs you the least. You will be comparing your current monthly payments with those of the refinanced mortgage and the second mortgage, assuming you release the same amount of equity with each. Here are some factors you should consider before making a decision.

Cash-Out Refinance

Which is cheaper depends to a great extent on the current interest rate compared to the rate of interest when you arranged your first mortgage. If the new mortgage has a lower rate than the existing mortgage, then cash-out refinance will enable you to repay the new mortgage at a lower interest rate than the first. However, because your principal is higher, your overall monthly repayment will be larger.

However, there are factors other than just the interest rate to take into consideration.

Mortgage insurance: Will you have to pay mortgage insurance on the new mortgage? With a second mortgage, the home itself is the collateral so you may not need insurance. Whether or not you have to pay mortgage insurance on the refinanced mortgage will depend on the equity remaining. If you have a good equity, it is unlikely you will be paying insurance now. It will be an additional charge until your equity builds back up to 20% of the loan amount. Even then, you sometimes still have to keep paying it.

When You Sell: How long do you intend living in your home? The longer the better.  If you intend moving shortly after consolidating your debts, then a second mortgage might be better for you.  You can carry that on to your next home. It costs more upfront to rearrange a mortgage, so you should only do that if you have no plans to move.

Other Factors: The amount you need will be a factor, since the more you borrow the better a lower interest rate will favor you. Your tax situation is also relevant, as are the respective terms of your first and refinanced mortgages.

Benefits of Cash-Out Refinance Vs. Second Mortgage

The main benefits of cash-out refinance are that you have only the one monthly payment to make compared with two for the second mortgage. You will also likely have a lower interest rate, although there is a rate where the two options break even with each other.  Generally, the higher your first mortgage rate, the more attractive refinancing becomes.

The main benefit of a second mortgage is that your first mortgage continues unaffected. It also has a fixed interest rate, so you know exactly what you are paying until it has been cleared. If you prefer, you can take your funds as a line of credit, where you pay interest only on what you draw.

If you are considering debt consolidation using your home equity, then these are your two main options. Choosing the better of cash-out refinance or a second mortgage for your situation can be difficult.  It is usually a good idea to seek independent advice from a mortgage adviser.