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Debt consolidation is a good way to help you save money in the right circumstances. Many homeowners use their mortgages to consolidate other high-interest rate debts into one lower monthly payment. How do you know if debt consolidation is the right choice for you? Our expert Katy mortgage lender team is here to explain how consolidating debt works, and whether it’s right for your financial situation.
How Does Debt Consolidation Work?
The purpose of debt consolidation is to take all of the outstanding debts that you pay each month and roll them into one monthly payment. Credit cards and non-secured loans tend to have pretty high-interest rates, whereas a mortgage has a lower rate of interest. Rather than paying off 3 or 4 credit cards with interest rates at 20% or more, you would be making one payment with an interest rate of around 4 to 5%, depending on your credit score. It could mean the difference of $1000 less a month and lower repayments. However, the savings may only be beneficial for the short term, depending on how long your mortgage term is.
Using Your Mortgage For Debt Consolidation
If you have at least 20% equity in your home, you can use your mortgage for debt consolidation. You are basically borrowing money from the equity in your home to pay off your other debts. The money that you borrow gets added to the outstanding balance of your mortgage. For example, if you have a mortgage for $100,000 and you borrow 50% of the equity from your home, the new mortgage will be for $150,000.
Pros of Debt Consolidation:
- Simplifies things because you are only making one payment a month rather than several.
- Home equity loans have a much lower interest rate than credit cards and unsecured loans.
- You can lower your monthly repayments.
Cons of Debt Consolidation:
- You are using your home as collateral.
- You run the risk of raising your debt load if you aren’t careful with your future spending. Paying off your debt just to rack up that same debt isn’t the way to go.
- You may have to pay fees or charges when you use your mortgage for debt consolidation, such as closing costs.
Things to Consider
Before you choose to consolidate your debt, you need to consider your overall financial situation and what the purpose is of borrowing against the equity in your home. If you are consolidating debt and using the extra funds to do a home renovation it can raise the value of the home in the long term and may be worth it. However, if you are paying off debts but aren’t taking the actions to stick to a better spending budget, you could end up in more debt somewhere down the road.
Key things to consider:
- Do you have at least 20% of your home equity built up? You may not qualify with most lenders if you have less than 20% of the home’s value paid off.
- Are the fees worth it? Check your mortgage contract’s terms and conditions to see if there will be fees involved and if you are allowed to borrow additional money.
- Does it make sense long-term?
Debt consolidation can lower monthly repayments, get you a lower rate of interest, and bring your credit score up in the short term. However, what is the long-term impact? Let’s say you have a personal loan of $10,000 with an 8% interest rate and a 2-year pay-off term. You will probably be paying around $450 each month. The same debt amount with a 6% rate of interest in a mortgage that has a 20-year term would cost you around $70 a month.
Now let’s look at this long-term. If you pay off the higher rate in a 2 year period you would be paying $10,800. Paying off the lower rate over a 20 year period could cost you over $6,000 more long-term. So if you are just looking to save money over time, it may not be the best option. However, in a situation where you are using the money saved from debt consolidation to improve your home, and those improvements add $10,000 to the home’s overall value, then it is worth it long-term.
Is Debt Consolidation Right For You?
This really depends on your situation and how much debt you have from how many lenders. If you are looking for a less expensive way to borrow money, it can benefit you a good deal as long as you create and stick to a good spending budget.
If you want to see if debt consolidation will work for you and your mortgage, give our Katy mortgage lender team a call today!