It can be stressful to juggle multiple debts at the same time. If you find yourself struggling to manage multiple debts, consolidating them into a single loan could help you manage your repayments better. One of the ways to do this is through refinancing your home loan.
If you already have a home loan, it may be possible for you to consolidate your other debts – such as a large credit card bill or a personal loan – into your mortgage.
As home loans typically have the lowest interest rates compared to other forms of credit, consolidating your other debts into your home loan could help you pay them off at a single, lower interest rate. If you find it challenging to keep track of multiple repayment dates, debt consolidation could free you from the hassle by allowing you to make a single monthly or fortnightly payment towards all your loans.
But does it make sense to refinance your mortgage for debt consolidation in every situation?
The answer to that question is complicated and depends on your situation. Despite the benefit of a potentially lower interest rate and the convenience of making a single monthly or fortnightly payment, debt consolidation may not be the right strategy for everyone. Here are some pros and cons worth considering before you decide to apply for a debt consolidation loan.
What are the pros and cons of refinancing your mortgage to consolidate debts?
If you are finding it challenging to manage the repayment schedules for multiple debts, consolidating your debts when you refinance your mortgage will leave you with a single ongoing repayment, which should be relatively simple to manage.
Consolidating your other debts into a lower interest rate home loan could also help reduce your total monthly repayment amount. Once you consolidate all your small debts into your mortgage, you are only charged interest once on the total amount, and at a lower rate in most cases. This can result in relatively smaller repayment amount than what you were paying individually on multiple debts. However, reducing your monthly outgoing doesn’t necessarily mean you’ll save money on your debts in the long run.
Even though home loans generally have lower interest rates than personal loans or credit cards, their term is typically much longer, with 25 to 30 years being the most common.
When you refinance a short term loan over a long duration, you can end up paying much more in total interest over the loan term than what you would have paid on your debts originally. For instance, paying a short-term credit card loan over 25 years can cost you significantly more despite a lower interest rate on refinancing. In such cases, it could be worth exploring other options like a balance transfer credit card that provides you up to two to three years to pay off your credit card debt at a low or zero promotional interest rate. Some balance transfer credit cards also let you use the service to pay off a personal loan.
Besides the risk of paying much more in interest over time, it’s also worth checking for any additional fees you may be required to pay. Depending on the type of debt you wish to consolidate, you could be hit with early repayment and exit fees that will add to your cost.
Another risk you may face is an increased interest rate on your home loan due to a higher Loan to Value ratio (LVR) when you add your credit card debt or personal loan balance to it. If the LVR increases to more than 80% of the property value, you may be required to pay for Lenders Mortgage Insurance (LMI), which could run into thousands of dollars depending on the size of your loan.
Is debt consolidation a good idea?
Whether or not debt consolidation is a good idea for you depends on your situation and financial objectives. Home loan refinancing for debt consolidation could help ease some of the pressure if you find yourself stretched out too thin between multiple debt repayments. On the downside, you could see yourself paying much more interest by extending your debt over a longer duration.
It’s also worth considering the impact of debt consolidation on your home equity. An increased loan amount will reduce the equity you have built into your home, which could impact your ability to secure a lower interest rate on refinancing. If you are not sure whether debt consolidation is a good idea for you, speaking with a mortgage broker may be helpful.
Remember that debt consolidation can help you improve your financial situation in the short term. However, if you are battling to keep up with your repayments, it may be better to seek help from a financial counsellor, as consolidating your loans into your mortgage could put your home on the line if you are unable to afford the repayments in future.
