What is debt consolidation?
Debt consolidation is a type of debt financing in which two or more debts are combined into one. A debt consolidation mortgage is a long-term loan that allows you to pay off multiple debts at once. After paying off your other debts, you will only have one loan left to make payments on.
Consolidation is especially effective for high-interest loans like credit cards. In most cases, the lender pays off all of the borrower’s debt and all of the borrower’s creditors at once.
Debt consolidation is an excellent strategy to streamline your finances.
How does debt consolidation work?
Dealing with high interest rate debts sometime feels like an uphill battle. These debt payments can eat up a significant portion of your monthly income and seem to take an eternity to pay off.
For instance, if you keep a balance on your credit card, you could be paying interest at a rate of 19.99%. The annual interest for a $5,000 balance on a high-interest credit card would be $999.50. If you only made a payment of $150 towards your credit card balance each month, only about $67 of that payment would go towards reducing the total amount that you owe. It would take you more than four years to pay it off in full, and you would end up paying $2,357 in interest.
Additionally, personal loans and lines of credit, payday loans, and auto loans can all cause financial stress. It might be challenging to advance financially when you have to manage so much high-interest debt. This is the primary reason why so many homeowners opt for debt consolidation mortgages.
In Canada, consolidating debt into a mortgage means breaking your present mortgage agreement and rolling high-interest debts (such as credit card debt, payday loans, and other non-mortgage liabilities) into a new mortgage with a reduced interest rate.
After you have completed this step, the amount of non-mortgage debt that you rolled into your mortgage will cause your total mortgage debt to grow by that amount, plus an additional couple thousand dollars to cover the cost of breaking the old mortgage. The benefit is that, theoretically, you will pay less interest on your non-mortgage debt.
If you are granted the loan, the majority of lenders would prefer that the money be put towards the immediate settlement of any existing debts you have (this is often done by an authorized 3rd party, such as a lawyer). With this, they can rest assured that your debts have been settled and that your debt service ratios are reasonable.
Any leftover money will be paid to you directly, generally by check or bank transfer, by the authorized 3rd party.
What are the advantages?
More cash available
Lower interest rates could make your payments smaller. As a result, you have more money each month to put towards savings, home expenses, or simply to pay off your mortgage faster.
Paying off high-interest consumer debt will lower your credit utilization, which will improve your credit score.
Consumer debt hurts your credit score more than mortgage debt. Your credit score should improve if you use mortgage loan to pay off credit card debt.
Long-term financial savings
Interest rates on credit cards and other consumer debts are far higher than those on a typical mortgage. If you only make the minimum payments, you will end up paying a lot more in interest. When you consolidate your debts into one loan, such as your mortgage or home equity line of credit (HELOC), you can pay off the loan sooner and end up saving money over time.
Save Time
Only one payment is required. No more checking several bills for balances.
Debt interest is lower.
You lower your monthly debt payment to one that’s far more manageable, consistent, and predictable.
What are the disadvantages?
The duration of your debt will increase
You won’t become debt-free any sooner if you consolidate other loans into your mortgage because you’ll have to pay them off over a longer period of time.
You risk depleting your available equity.
To some, their home is like an ATM they use whenever they need some money . However, equity is not a resource with an infinite supply. If you use up your equity, you may not have enough in case of a job loss or a medical emergency.
You might accumulate additional debt.
Many consumers continue to use their credit cards after debt consolidation. They eventually end up further in debt to their credit card companies as well as their mortgage company.
Excessive credit card debt can also jeopardize the loan.
If you agree to pay off your credit cards and close the accounts, you might be able to qualify in some circumstances; however, closing the accounts (especially the older ones) could possibly hurt your credit score.
It is not guaranteed that you’ll be approved for a debt consolidation mortgage.
A minimum amount of equity is required; this is the difference between the value of your property and the amount owed on your mortgage.
The root cause is not resolved
Some people might not modify the spending patterns which led to the high interest rate debt crisis.
What do I need to get started?
You may find debt consolidation helpful if you want to make your debt payments more consistent and predictable. Also, rather than making multiple payments like before, you now only make one smaller monthly payment. Also, you will have the opportunity to save money on interest!
Would you like to explore this solution a bit further? Contact us so we can talk!
