Cash out a mortgage is a way of unlocking your home equity. It is refinancing an existing mortgage for a higher amount than you owe and keeping the difference.
But is paying off your car loan with mortgage refinancing a smart move? There is no universal answer. Normally, there is no limitation to what one can do with the cash. It is therefore a personal decision.
However, not many financial advisors will advise you to pay off a car loan with cash out mortgage. So when should you consider it?
Serious Shortage in Cash Flow
Say your income has been greatly affected and you are wondering what to do about the car loan, cash out mortgage may be a good idea. This will allow you to clear the car loan and remain with payment of the new mortgage.
Your monthly repayment either goes down or spread out over a longer period of time. It is likely that this plan can leave you with some cash.
High Debt Level
By October 2018, US Consumer Debt had risen to $3.964 trillion. $2.926 trillion of this was non-revolving debt which includes auto loans. Evidently, many Americans are living in debt.
The only way to get rid a debt is to pay off. Cash out mortgage is a good option in reducing debt. Consolidating debt can also help to improve your credit score if it reduces your monthly repayment.
When Home Value is Increasing
It would not make financial sense to refinance a mortgage that has not appreciated, especially to take care of a car loan. You should only consider refinancing when home prices are rising.
Cash out mortgage is not automatically given to every homeowner. There are rules that guide the facility. They include:
- Minimum credit score: According to FHA, one must have a credit score of 580. Other lenders may require a credit score of 600 – 620
- You must have owned the home for at least one year
- Have a loan-to-value (LTV) ratio of 80% although it differs with different lenders. LTV is the ratio of your home`s value to the amount you intend to borrow against it.
Here are some benefits of using cash out mortgage to pay off a car loan:
Shorter Repayment Period
Paying off a car loan also frees up cash which can increase monthly mortgage repayment. Cash out mortgages have a repayment period of 15 to 30 years. By clearing other debts like a car loan personal loan , instalment loans from website such as nation21loans, you can repay the refinancing mortgage within a shorter period, reducing the interest amount.
The Tax Advantage
Mortgage interest is tax deductible while a car loan is not. By moving the car debt to mortgage debt, you reduce taxable income and potentially increase tax refund.
This could save you thousands of dollars in a year. It is however important to ensure you itemize the deductions on your tax returns for the tax deduction to be affected.
From Fluctuating to Fixed Interest Rate
Interest rates have been on the increase in the last few years. Some experts predict that they will continue to rise, even though it is hard to predict by how much. Using your cash out mortgage to pay your car loan locks the interest in to a low rate.
Ensure to take a mortgage with a fixed loan rate. This will keep you safe from the interest rates that keep going up and down.
With such benefits, how come there are financial advisors who think paying a car loan with cash out mortgage is a bad idea?
It is Expensive
For example, say your car loan is $20,000. If repayment period is 5 years at 5% interest, your interest will be $2,645. If you cash out mortgage to pay off the same car loan, you extend repayment time to say, 30 years. Even if the interest rate remains at 5%, you will pay a total of $18,651.
Paying a loan over a long period of time is clearly, much more expensive.
This refers to the risk of losing your home because of financial distress. Remember that your home acts as collateral for any kind of mortgage. Should you suffer any financial set back and fail to make monthly repayments, you risk losing the home.
Private Mortgage Insurance
Most lenders will waiver private mortgage insurance (PMI) if a mortgage refinancing is less than 80%. But if you borrow more than 80% of your home value, a PMI will be charged.
For example, if your home is worth $200,000 and you do a cash out refinance for $160,000, you will have to pay PMI. This is a fact that should not be ignored when considering cash out mortgage.
Factors to consider before applying for a cash out mortgage to pay off a car loan:
- The value of your home. Include the state of exterior and interior look
- Refinancing interest rates versus car loan interest rates
- Cash out mortgage closing costs
- Your credit score
- Tax deductibility on your loans
- Current and future cash flow
Consider these carefully if you want to have a great experience. When it comes to debt, it’s good to strive to focus on other forms of debt that can positively impact your bottom line.
The option of using cash out mortgage to pay off a car loan should be taken if it has a positive impact on your finances, whether short or long term. Lack of proper projection or taking the refinancing just because it is available might put you in serious financial problems. Make sure you consider this well and in consultation with experts.
A study done by HIS Markit in 2017 noted that on average, Americans keep their cars for 6.6 years. If you are average and your new mortgage`s repayment period is 30 years, you will be paying for your car for well over 23 years after you have sold it.
It is important to weigh carefully and ensure it is a smart decision. Whether it stems from serious need or pure pleasure. A wise decision here can save you a lot of headaches.