The average adult American has multiple credit cards and a variety of other debts from car payments to mortgages. In fact, according to the New York Federal Reserve, the average U.S. household with any kind of debt, credit card, student loan, auto and/or mortgages owes $134,643. With that size of debt, it’s no surprise that bills can become overwhelming. Many consumers find themselves spending a significant portion of their income on bills, wishing for ways to lighten their load. Homeowners that want to simplify their finances and begin getting out of debt can refinance their mortgage and consolidation debt.
Is this a wise strategy? What implications should homeowners be aware of before considering refinancing a mortgage for debt consolidation?
What is a debt consolidation loan?
A debt consolidation refinance is a loan that allows homeowners to consolidate their unsecured debts into their mortgage loan. Assuming that a homeowner has built up sufficient equity in their home, he or she may be able to refinance, using their home’s equity to pay off other debts. This will leave the homeowner with one monthly payment, instead of struggling to keep up with several different payments each month.
For mortgages and refinances, a debt consolidation option would be in the form of a line of credit on the equity in your home (HELOC).
The benefit of a HELOC is that interest rates are typically low. Most HELOC options require interest-only payments during the first 10 years which means homeowners have the chance to catch up on their outstanding debts.
Should I refinance my home to consolidate debt?
There are a few factors to consider when deciding to refinance your mortgage while using consolidation. The first thing that you will need to understand is that you will be turning your unsecured debts, into a secured debt. If a consumer begins to struggle financially and cannot continue to make one of their credit card payments, their credit will suffer, their interest rates will increase, and they will probably begin receiving frequent calls from a debt collector.
While none of these consequences are ideal, the consequence of failing to make your mortgage payment is much more severe. If you consolidate your debt into your mortgage loan and fail to make the payments, you could lose your home.
Also, those who refinance their mortgage while using consolidation must be willing to pay closing costs and other fees. Consolidation is not free. While you can shop around and find a great deal, you will still be required to pay for the loan. However, in most cases, closing costs and other fees are rolled into the loan. This means that you will not be required to pay the closing costs out of pocket. Unfortunately, this also means that you will pay interest on these fees.
Finally, with a HELOC you are spreading your debt out over a longer period, which means you will likely end up paying more in interest over the life of your loan. Use a mortgage calculator to determine how much you’ll be spending, overall, with a HELOC. Is it worth the instant gratification you will receive?
What are the benefits of refinancing your mortgage into a debt consolidation loan?
For every negative, there are also many benefits to refinancing using a debt consolidation loan. These loans help homeowners consolidate their bills into one monthly payment. Consumers that sometimes forget when bills are due and tend to rack up late fees, will especially find this to be convenient.
Consolidating to a secured loan can significantly reduce your interest rates. Many consumers are paying around 8 to 21 percent interest on their credit cards each month, by comparison, current mortgage rates are closer to the 3–4 percent range. While you will still owe the same amount, your debt consolidation loan will feature a much lower interest rate. This may help you reduce your monthly payments and have more disposable income each month. Some of this income can even be put towards the consolidation loan, which will help you lower the balance of the loan and get out of debt faster.
Who best qualifies for a debt consolidation loan?
Before making the leap toward debt consolidation, ask yourself a few question:
- Am I serious about paying off my debts?
- Will I be responsible with the money I am saving each month?
- If I consolidate, will my debt be manageable?
- Am I in debt because of lack of financial discipline?
- Can I get a lower interest rate by consolidating debt?
- How is my credit score?
Debt consolidation can have serious repercussions when not taken seriously – you’re borrowing against your home. This makes it incredibly important to self-assess if debt consolidation truly is the best option for you. Ask yourself the hard questions. Will you use your monthly savings to pay down debts? Even with an option like a low interest HELOC, your debts could be unmanageable. Are you confident this solution will be an affordable one?
If you think that your debt is attributed to a larger financial problem – like unnecessary discretionary spending – it is wise to work with a financial advisor before independently trying to solve the problem. There are many resources available to help get your finances back on track.
If you decide to consolidate your debt, make a plan. As with any refinance product, compare a variety of lenders to find the best rate. Also, make a budget and stick to it. These are surefire ways to ensure you’re getting the best rate, and sticking to your commitment.
Consumers who are struggling with debt have a number of options to consider. Before deciding to refinance your mortgage while using consolidation, it is important to determine whether this option will help to reduce your monthly bills while benefiting you in the long run.