“I want to consolidate my debt, but … do I combine it with my mortgage?”
There is no question paying off your debt is smart. But how you pay it off is key to your financial fitness. If you are a homeowner you can reduce debt payments, improve cash flow and reduce interest payments by wrapping personal unsecured debt into your mortgage. But is this always a wise choice?
How it works
At the time of mortgage refinancing home-owners are often asked whether they have unsecured debt, like credit cards, lines of credit or personal loans they would like to add to their mortgage. If the home-owner decides to add these balances to the mortgage the lender pays off the personal unsecured debt.
Why it works
Since the loan is secured by the equity in the borrowers’ home the interest rate is typically lower than the rates on credit cards and personal loans. This means on a monthly basis less interest is being paid. With a longer amortization period, monthly payments are lower than the payments of the original mortgage plus the other debt. This means an improvement in monthly cash flow.
What you need to be concerned about
While this type of debt consolidation is very appealing it is not without its’ pitfalls. The first, and one that is most common, occurs when instead of cutting up your credit cards after consolidating, spending continues and very quickly you find yourself over-borrowing. In order to take advantage of a mortgage consolidation it is critical that once credit cards, lines of credit and personal loans are paid off, they remain paid off.
While a lower interest rate means lower monthly interest costs, extending the term of your loan
means in most cases more cumulative interest will be paid over the long term. Be clear on this, you are not saving interest; you are just lowering the amount of interest paid each month.
Increasing the size of your mortgage by adding additional personal debt means you are decreasing equity. The lower your equity the higher the interest rate you will pay when you renegotiate your mortgage next. Should market prices decline, your equity position becomes even smaller. Continue in the cycle of consolidating in your mortgage, which is very easy to do in an umbrella mortgage, and you never own your home because you never pay off your mortgage.
The most serious pitfall is the risk of losing your home. Should anything happen in your personal circumstances and you are unable to make your mortgage payments your home can be repossessed.
How to decide
If your additional debt is small consider making small changes in your lifestyle and working on a budget to pay down your debt faster. If consolidation is appealing, do it outside of your mortgage in a personal consolidation loan. You will still have a lower interest rate and be able to pay off your debt in equal monthly payments.
If you are diligent in your spending habits and once credit cards and lines of credit are paid off, and you are disciplined enough to either never use them or pay off balances in full, then this type of consolidation can be beneficial for improving monthly cash flow and making finances more manageable
Not sure if this is the right way to clean up your finances? Come in or give us a call. We want to C.U. and help you figure out what your best options are.