Combine your debts into one manageable repayment
Refinancing to a debt consolidation mortgage can lead to cost savings if you are disciplined with your payments and you make a conscious effort to pay it off early, but be mindful of the risks and costs involved.
What is refinancing?
Refinancing to a debt consolidation loan involves reviewing your existing debts (and mortgage), and combining them into a new mortgage so that you have one monthly repayment, instead of several repayments.
Many consolidate their debts to try and make their loan repayments more affordable. However, this strategy must make financial sense where the cost of the new loan including fees and interest is less than what you are currently paying on all your debts.
What type of debts can I consolidate?
- Credit cards
- Personal overdrafts
- Car loans
- Personal loans
How can I refinance to a debt consolidation loan?
- Identify your needs. Consider your lifestyle and borrowing needs. What features do you need from your new lender? Do you have a contingency buffer in place to cover your payments if you lose your job? Do you have the discipline to manage the payments?
- Speak to your lender. Contact your existing lender to see if you can negotiate the interest rate offered with your current mortgage. This may ease some financial pressure from your mortgage, which may allow you to focus on servicing your other debts. However, if it’s a different loan type or features that you’re after, then it may be time to refinance.
- Calculate refinancing cost. Remember that you may need to pay a fee to exit your current mortgage. With your new debt consolidation loan, you’ll need to pay upfront costs such as application fees or legal fees charged by the new bank.
- Compare refinance mortgages. Speak with a mortgage broker to discuss the type of debt consolidation loan that will be best for you. You may want to scout for a mortgage with the ability to make additional repayments.
What factors should I consider in a debt consolidation mortgage?
One of the key things you need to know are the costs of exiting your current mortgage and switching to a new one, as well as the impact of longer terms on your accumulated interest.
- Interest rates. Check both the interest rates of the old debts and the interest rate of the new mortgage. Decide whether you want a fixed or variable interest rate.
- Longer terms. While the lower monthly payments may be appealing, stretching a short-term debt such as a credit card or personal loan over a longer term will mean you’ll pay more interest. For instance, if you took out a $10,000 personal loan at 14.5% interest over 5 years, you would have monthly payments of $235 and total interest payable of $4,117. However, if you decided to consolidate this debt into your refinanced mortgage over 30 years (even at an average interest rate of 4.5%), the total interest payable on this portion of the loan would be significantly higher as it is stretched out over a longer term.
- Annual or service fees. It’s important to know what fees and charges are applicable during the life of your loan. Even small ongoing fees can add up, which could defeat the purpose of refinancing in the first place.
- One-time fees. These range from fees charged to exit your current loan to new fees such as closing costs on your mortgage.
- Your existing loan. If you’re ahead with your mortgage payments, then you may want to consider borrowing against the mortgage to pay out your existing debts. This is usually less costly and extends your loan period by a small period of time.
- Should you use a mortgage broker? A mortgage broker can discuss your personal situation with you and identify the costs of refinancing your home loan. They can also advise on the best way to use this new loan to get the most out of it.
What are the pros and cons?
Advantages
- Convenience. Refinancing with a debt consolidation mortgage allows you to repay all of your debts with one manageable repayment. These debts can include existing credit cards and personal loans.
- Save money. If implemented correctly, you can save money on interest if you make a conscious effort to repay the loan as quickly as possible.
- Access equity. Unlocking the existing equity in your home at a lower interest rate can be a good way to fund renovations on your existing property.
Disadvantages
- Fees. You may have to pay exit fees to get out of your existing loans, as well as fees for setting up your new mortgage.
- You pay more overall. You could be paying interest on your credit card debt for as long as 30 years, which could cost you more in the long run.
- Risk. If you fail to make your new, higher monthly mortgage payments, the bank could foreclose on your house.
Bottom line
Refinancing your home loan to consolidate debts is a step that should be taken with caution. Even though the potential savings you can make seem enticing, you always need to offset the savings with the costs of refinancing. If you’re experiencing mortgage stress, remember that you should always talk to your current lender first.
Frequently asked questions
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