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If you’re trying to pay down debt and you own a home, you may be wondering whether it makes sense to use a cash-out refinance to pay off debt.

There are pros and cons to going this route, and it’s important to understand how the process works to help decide if it’s the right option for you.

Read on to find out how to use a cash-out refinance to pay off debt, the costs involved, the benefits and drawbacks, and other options for repaying debt you owe.

Using a Cash-Out Refi to Pay Off Debt

In mid 2023, household debt (not including mortgages) in the U.S. exceeded $4.7 trillion dollars, according to a report released by the Federal Reserve Bank of New York. It’s no wonder then that individuals are looking for ways to get out from under the debt they owe.

A cash-out refinance for debt consolidation allows you to use the equity in your home to pay off debt by taking on a new mortgage. The new mortgage pays off your old mortgage and it comes with new terms, including a new interest rate that’s potentially lower, and length of time to repay the loan. The new mortgage terms may be better than your original mortgage, but it’s also possible they may not be as favorable.

Here’s a quick course in cash-out refinancing 101 and how it works:

Determine How Much Cash You Need

When you’re considering a cash-out refinance to pay off debt, first figure out how much money you’ll need. To do this, add up all the debts you want to pay off. Include things like credit card and personal loan debt and medical bills.

Determine How Much You Can Borrow

The amount you can borrow with a cash-out refinance depends on how much equity you have in your home. Equity is how much your home is worth compared to how much you owe. Typically, you can borrow up to 80% of your home’s market value.

Here’s an example of how cash-out refinancing works: Let’s say your home is worth $500,000 and you owe $300,000 on your current mortgage. That means your home equity is $200,000. With a cash-out refinance loan, a lender might let you borrow up to 80% of your equity (as long as you qualify for that amount), which is $400,000.

You’ll need to use that $400,000 to pay off the $300,000 you owe on your mortgage and also closing costs. That leaves you with about $100,000 in a cash out refinance for debt consolidation.

Prepare Your Cash-Out Refinance Application

Your cash-out refinance application is much like the mortgage application you filled out when you bought your house. Lenders will look at and evaluate such factors as your:

•   Credit score: Many lenders look for a minimum credit score of 620 for a cash-out refinance

•   Debt-to-income (DTI) Ratio: DTI compares your monthly debts to your gross monthly income. In order to qualify for a cash-out refinance, lenders typically look for a DTI of less than 50%.

•   Home equity: As mentioned above, you’ll likely need at least 80% equity in your home.

You may need to provide the lender with documents such as bank statements and W-2s.


💡 Quick Tip: Thinking of using a mortgage broker? That person will try to help you save money by finding the best loan offers you are eligible for. But if you deal directly with an online mortgage lender, you won’t have to pay a mortgage broker’s commission, which is usually based on the mortgage amount.

Complete the Closing and Pay Closing Costs

If the cost to refinance a mortgage makes sense for you, and you qualify with a lender, you’ll pay closing costs to cover such fees as credit reports and appraisals. Closing costs may be wrapped into the refinanced loan amount. After you close on the loan you’ll receive your funds.

If You’re Consolidating Debts, Let The Lender Know

It’s possible that your debts may be high enough to preclude you from qualifying for a cash-out refinance. However, if the lender knows you’ll be consolidating debts, they can include those debts in your loan amount for consolidation.

That way you’ll be paying off the debts in one payment with the new interest rate (ideally, a lower one) you received with your cash-out refinance.

Benefits of Cash-Out Refinancing to Pay Off Debt

When you consolidate debts with a cash-out refi, you have just one monthly payment to make. That’s usually more manageable than trying to pay multiple bills all at once.

There are other potential benefits as well.

Consolidating Debts Can Lead to Savings

High-interest debt can be difficult to pay back. Credit card APRs can reach 29.99% or higher, which adds to the amount you need to pay each month. When you consolidate debt with a cash-out refinance, you may save money on interest costs.

Cash-Out Refinancing Can Pay Debts Quickly

When you take out a cash-out refi to tackle the debt you owe, you may be able to pay off certain debts faster than you would have otherwise. You’ll likely be paying less in interest, which could allow you to put more money toward the debt balance.

Impact On Credit Score

Paying off high-interest debts with a cash-out refi could lower your credit utilization rate, which is the amount of credit you’re using. Credit utilization is an important factor in your credit score.

Should You Use a Cash-Out Refinance to Pay Off Credit Card Debt?

Interest rates on credit cards are typically high, and can be more than 30%. The interest rate on a mortgage tends to be much lower. If you can get a lower interest rate to repay your debt, a cash-out refinance could be worth it. However, if you choose this method, be careful to avoid overspending and running up credit card debt again. Changing your spending habits can be critical to staying out of debt.

Drawbacks of Using a Cash-Out Refinance to Pay Off Debt

A cash-out refinance also has some significant disadvantages to consider. These include:

Increased Monthly Mortgage Payment

When you take out a bigger loan amount, you may also end up with a higher monthly mortgage payment. You’ll be responsible for paying that higher amount each month.

Turning Unsecured Debt Into Secured Debt

Another factor to consider is that if you can’t pay back everything you borrow with a cash-out refinance, you could be in danger of losing your home. That’s because a mortgage is secured debt, and your home is collateral for the loan. While that’s true with any mortgage, with a cash-out refinance you are likely borrowing even more money since you’re using the extra cash to tackle debt, which means there’s more for you to repay.

Closing Costs

When you refinance a mortgage, including a cash-out refinance, you need to pay closing costs. These costs can be around $5,000 according to Freddie Mac. However, the size of your loan and where you live can affect how much your closing costs may be.

Cash-Out Refinance vs. Debt Consolidation

With a cash-out refinance, you take out a new mortgage to repay your old mortgage and also get cash you can use for a variety of purposes, including paying debt. With debt consolidation, you combine all your debts into one loan. A debt consolidation loan is not secured by your home; a cash-out refinance loan is.


💡 Quick Tip: Because a cash-out refi is a refinance, you’ll be dealing with one loan payment per month. Other ways of leveraging home equity (such as a home equity loan) require a second mortgage.

Alternatives to Cash-Out Refinance Loans

A cash-out refi isn’t your only option for paying off debt. Here are some other methods to consider.

Home Equity Line of Credit (HELOC)

A home equity line of credit is secured by the equity in your house. It’s similar to a line of credit, so you borrow just what you need when you need it, and you only pay interest on what you borrow. However, if you don’t pay off a HELOC you may be in danger of foreclosure.

Home Equity Loan

With a home equity loan, you receive a lump sum of money and make regular fixed payments. Interest rates tend to be higher than they are for a cash-out refinance, and you will need to pay closing costs.

Personal Loan

A personal loan is an unsecured loan that you can use for almost any purpose, including debt consolidation. These loans generally come with higher interest rates than a cash-out refinance, HELOC, or home equity loan. They also have a shorter term, which means you’ll need to make higher monthly payments. But that also means the loan will be paid off sooner.

Balance Transfer Credit Card

A balance transfer credit card typically offers a 0% introductory rate for a number of months (up to about 21 months) on debt you transfer from another source, which is usually another credit card. There is a balance transfer fee of around 3%, but you won’t won’t owe interest on the balance you transfer. If you have a lower debt amount that you can pay off in a relatively short amount of time, this option might make sense. However, to qualify for the 0% rate, you’ll typically need a strong credit score.

The Takeaway

If you need to pay off high-interest debt and you have sufficient equity in your home, a cash-out refinance can be an option worth exploring. It can give you a lower interest rate, as long as you qualify, which could help you save money. However, keep in mind that you will need to pay closing costs when refinancing, and the terms of the loan, including the length of the loan, will change.

Turn your home equity into cash with a cash-out refi. Pay down high-interest debt, or increase your home’s value with a remodel. Get your rate in a matter of minutes, without affecting your credit score.*

Our Mortgage Loan Officers are ready to guide you through the cash-out refinance process step by step.

FAQ

Can I use a cash-out refinance to pay off both secured and unsecured debts?

Yes. A cash-out refinance can be used to pay off a variety of debts, including secured debts as well as unsecured debts, like credit cards.

Are there any tax implications of using a cash-out refinance for debt repayment?

If you use a cash-out refinance for debt repayment, you won’t owe taxes on the money you receive from the cash-out refi. That’s because the money is considered a loan that needs to be paid back, and not income. At the same time, per IRS guidelines, you typically can’t deduct the interest on a cash-out refinance if you use the money to pay off debt.

What factors should I consider when deciding whether to use a cash-out refinance for debt repayment?

If you have high-interest credit card debt, and you can get a lower interest rate to repay your debt with a cash-out refinance, it may be worth it for you. But first make sure you can change your spending habits to avoid overspending and running up credit card debt all over again.

Also, consider the fact that your monthly mortgage payment will likely be higher with a cash-out refinance. Can you afford that higher amount? And you’ll also have to pay closing costs. Calculate to be sure that the amount of cash you’ll get from the cash-out refi is sufficiently more than what you’ll spend on closing costs.

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Photo credit: iStock/fizkes

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

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Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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*SoFi requires Private Mortgage Insurance (PMI) for conforming home loans with a loan-to-value (LTV) ratio greater than 80%. As little as 3% down payments are for qualifying first-time homebuyers only. 5% minimum applies to other borrowers. Other loan types may require different fees or insurance (e.g., VA funding fee, FHA Mortgage Insurance Premiums, etc.). Loan requirements may vary depending on your down payment amount, and minimum down payment varies by loan type.

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Editor's Note: For the latest developments regarding federal student loan debt repayment, check out our student debt guide.

If you’re having trouble making your student loan payments or just want to know if you can make a change to your payments, it’s worth looking into the options, such as refinancing student loans or an income-driven repayment plan.

Student loan refinancing is available for both private and federal student loans, while income-driven repayment plans are an option only for federal student loans. Proposed changes to income-driven repayment would lower monthly payments and curtail interest accrual, making the plans a better deal for borrowers. Here’s what to know about both options as well as the pros and cons of each.

What Is Student Loan Refinancing?

When you refinance a student loan, a private lender pays off your student loans and gives you a new loan with new terms. For example, the interest rate and/or the loan term may change. You can’t refinance loans through the federal government, however. You can only refinance federal student loans (or private student loans) through a private lender.

If you’re a graduate with high-interest Direct Unsubsidized Loans, Graduate PLUS loans, and/or private loans, a refinance can change how quickly you pay off your loans and/or the amount you pay each month.


💡 Quick Tip: Ready to refinance your student loan? With SoFi’s no-fee loans, you could save thousands.

Pros of Student Loan Refinancing

When considering refinancing your student loans, there are several benefits. You can:

•   Lower your monthly payments: Lowering your monthly payment means you can save money or spend more in other areas of your life instead of putting that cash toward paying student loans. (Depending on the length of the loan term, however, you may end up paying more in total interest.)

•   Get a lower interest rate than your federal student loan interest rates: This can result in paying less interest over the life of the loan (as long as you don’t extend your loan to a longer term). A student loan refinance calculator can show you the interest rate you qualify for.

•   Decrease your debt-to-income ratio (DTI): Your DTI compares your debt payments to your income. So if you lower your monthly payments, you could be lowering your DTI ratio — and a lower DTI can help when applying for a mortgage or other type of loan.

•   Remove a cosigner. Many borrowers who took out undergraduate loans did so with a parent or other cosigner. Refinancing without a cosigner allows you to regain some financial independence and privacy, provided you have a strong credit history.

Recommended: What’s the Average Student Loan Interest Rate?

Cons of Student Loan Refinancing

That said, refinancing federal loans can have some drawbacks as well. They include:

•   No longer being able to take advantage of federal forbearance: When you refinance your student loans through a private lender, you no longer qualify for federal student loan forbearance, such as the Covid-19-related payment holiday. However, it’s worth noting that some private lenders offer their own benefits and protections after you refinance.

•   No longer being able to tap into income-driven repayment plans, forgiveness programs, or other federal benefits: Refinancing federal student loans means replacing them with private loans — and forfeiting the protections and programs that come with them.

•   Possibly seeing your credit score get dinged: Your lender may do a hard credit history inquiry (or pull), which can affect your credit score.

For a deeper dive into the topic, check out our Student Loan Refinancing Guide.

What Are Income Driven Repayment Plans?

Put simply, income-driven repayment plans are plans that base your monthly payment amount on what you can afford to pay. Under the Standard Repayment Plan, you’ll pay fixed monthly payments of at least $50 per month for up to 10 years. On the other hand, an income-driven repayment plan considers your income and family size and allows you to pay accordingly based on those factors — for longer than 10 years and with smaller loan payments. Income-driven repayment plans are based on a percentage of your discretionary income.

You can only use an income-driven repayment plan for federal student loans. If you qualify, you could take advantage of four types of income-driven repayment plans:

•   Saving on a Valuable Education (SAVE) Plan: You typically pay 10% of your discretionary income over the course of 20 years (for loans for undergraduate study) or 25 years (for loans for graduate or professional school).

•   Pay As You Earn Repayment Plan (PAYE Plan): You typically pay 10% of your discretionary income but not more than the 10-year Standard Repayment Plan amount over the course of 20 years.

•   Income-Based Repayment Plan (IBR Plan): As a new borrower, you typically pay 10% of your discretionary but never more than the 10-year Standard Repayment Plan amount over the course of 20 years. If you’re not a new borrower, you’ll pay 15% of your discretionary income but never more than the 10-year Standard Repayment Plan amount over the course of 25 years.

•   Income-Contingent Repayment Plan (ICR Plan): As a new borrower, you typically pay the lesser of the two: 20% of your discretionary income or a fixed payment over the course of 12 years, adjusted according to your income over the course of 25 years.

How do you know which option fits your needs? Your loan servicer can give you a rundown of the program that may fit your circumstances. You must apply for an income-driven repayment plan through a free application from the U.S. Department of Education.

Note: Every income-driven plan payment counts toward the Public Service Loan Forgiveness Program (PSLF). So if you qualify for this program, you may want to choose the plan that offers you the smallest payment.

Recommended: How Is Income-Based Repayment Calculated?

Pros of Income Driven Repayment Plans

The benefits of income-driven repayment plans include the following:

•   Affordable student loan payments: If you can’t make your loan payments under the Standard Repayment Plan, an income-driven repayment plan allows you to make a lower monthly loan payment.

•   Potential for forgiveness: Making payments through an income-driven repayment plan and working through loan forgiveness under the PSLF program means you may qualify for forgiveness of your remaining loan balance after you’ve made 10 years of qualifying payments instead of 20 or 25 years.

•   Won’t affect your credit score: This may be one question you’re wondering, whether income-based repayment affects your credit score? The answer is: no. Since you’re not changing your total loan balance or opening another credit account, lenders have no reason to check your credit score.

Cons of Income Driven Repayment Plans

Now, let’s take a look at the potential downsides to income-driven repayment plans:

•   Payment could change later: The Department of Education asks you to recertify your annual income and family size for payment, which is recalculated every 12 months. If your income changes, your payments would also change.

•   Balance may increase: Borrowers under the PAYE or IBR plan receive a three-year interest subsidy from the government. However, after the subsidy expires, borrowers are responsible for paying the interest that accrues on subsidized and unsubsidized loans.

•   There are many eligibility factors: Your eligibility could be affected by several things, including when your loans were disbursed, your marital status, year-to-year changing income, and more.

Refinancing vs Income Driven Repayment Plans

Here are the factors related to refinancing and income-driven repayment plans in a side-by-side comparison.

	Refinancing	Income-Driven Repayment Plan
Lowers your monthly payments	Possibly	Possibly
Changes your loan term	Possibly	Yes
Increases your balance	Possibly	Possibly
Is eventually forgiven if you still haven’t paid off your loan after the repayment term	No	Yes
Requires an application	Yes	Yes
Requires yearly repayment calculations	No	Yes

Choosing What Is Right for You

When you’re considering whether to refinance or choose an income-driven repayment plan, it’s important to take into account the interest you’ll be paying over time. It could be that you will pay more interest because you lengthened your loan term. If that’s the case, just make sure you are comfortable with this before making any changes. Many people who refinance their student loans do so because they want to decrease the amount of interest they pay over time — and many want to pay off their loans sooner.

That said, if you’re wondering whether you should refinance your federal student loans, you’ll also want to make sure you are comfortable forfeiting your access to federal student loan benefits and protections.

Refinancing Student Loans With SoFi

Refinancing your student loans with SoFi means getting a competitive interest rate. You can choose between a fixed or variable rate — and you won’t pay origination fees or prepayment penalties.

Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.

With SoFi, refinancing is fast, easy, and all online. We offer competitive fixed and variable rates.

FAQ

Is income-contingent repayment a good idea?

This plan may be a good idea for some borrowers because the repayment terms are based on the lesser of these two: 20% of your discretionary income or a fixed payment over the course of 12 years, adjusted according to your income over the course of 25 years. Any remaining balance will be forgiven if you haven’t repaid your loan in full after 25 years. Because of the longer repayment timeline, the drawback is borrowers may pay more over time. It also won’t provide payments as low as the SAVE Plan.

What are the disadvantages of income based repayment?

The biggest disadvantage of income-based repayment is that you stretch out your loan term from the standard repayment plan of 10 years to longer — up to 25 years. This means that more interest will accrue on your loans and you could end up paying more on your loan before your loan term ends.

Does income based repayment get forgiven?

Yes! Through the Public Service Loan Forgiveness (PSLF) program, student loans can be forgiven after making 10 years of qualifying, consecutive payments. Additionally, borrowers with an income-driven repayment plan can have the remaining balances on their loans forgiven after 20 or 25 years.

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Photo credit: iStock/m-imagephotography

SoFi Student Loan Refinance
If you are a federal student loan borrower, you should consider all of your repayment opportunities including the opportunity to refinance your student loan debt at a lower APR or to extend your term to achieve a lower monthly payment. Please note that once you refinance federal student loans you will no longer be eligible for current or future flexible payment options available to federal loan borrowers, including but not limited to income-based repayment plans or extended repayment plans.

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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