What you need to know about consolidating debts into your mortgage
Have you ever consolidated credit cards, personal loans or other forms of debt into your mortgage? It is quite commonplace these days and while it has it’s merits, I often wonder whether people fully understand what consolidating debts into a mortgage really does for your finances.
Whether you have already consolidated your debts or perhaps you are only just starting to think about it, I wanted to share with you some things you must consider prior to bringing all of your debts under the one home loan.
My goal here is to not sway you for or against the topic, it’s to inform you of the consequences so you can understand the full implication (and benefit) of bringing personal debt into your mortgage.
So why is consolidating your debts into the mortgage so popular? The attractiveness of consolidating debt is three fold;
But before we go on, why is it that consolidating debts i
To make it very easy, there are three main reasons that someone would look to consolidate their debts into their mortage.
It’s a popular debt strategy as it helps you:
- Reduce your debt repayments (if the interest rate is lower).
- Helps you consolidate your finances so you make only one repayment, not many.
- Extend your debt timeframe, giving you longer to repay (which is good and bad).
Here is what you must know about consolidating debts into your mortgage
Your debt will go from unsecured debt to secured debt
A credit card is considered unsecured debt. This means no asset you own is secured to it, in turn if you default on your credit card, there is little the banks can do beyond enforce a repayment plan and work with you to recover their money.
A secured debt is one that has the backing of an asset that the bank could sell if things went bad. For instance, a mortgage is backed by the property. If you can’t repay your home loan, the bank will sell your house – simple.
Now the problem with consolidating credit cards and personal loans into your mortgage, is that you make those debts all of a sudden become ‘secured’ by your property. This means that while you are likely getting a better interest rate on your debts by consolidating them, you have effectively increased your risk exposure to losing your house significantly (depending on the size of your debts).
In simple terms; consolidating credit cards and personal loans into your mortgage turns them from unsecured debts to secured debts.
You will end up taking longer to repay your debts
Another thing that many people do is consolidate their debts into their mortgage and then continue to make minimum repayments (that are set out of a 20-30 year period). This means your debt is going to take a lot longer to repay than when you didn’t have it in the mortgage.
This often allows people some rest if money is extremely tight. If you are going to use the full length of your mortgage to repay the consolidated portion of your debt, just remember that it is going to cost money to have that comfort.
The trick? Make higher repayments until you kill the portion of the consolidated debt. You don’t want to last the full length of your loan. Set yourself a goal to make larger repayments and utilise the low interest rate of a mortgage properly.
For example; if you did consolidate $20,000 of credit card debt onto your mortgage, you should aim to make extra large repayments until you completely kill $20,000 on your mortgage. This will mean you pay less interest and don’t fall into the trap of repaying the $20K debt over the full 20-30 years of your mortgage.
Consolidating debts into your mortgage means lower interest rates but more interest payable
Your interest rate may be lower on your mortgage, however you will still be paying more interest if you don’t have a repayment strategy in place.
A side effect of taking longer to repay your debt (as mentioned above) means more interest payable.
You don’t want to alleviate yourself from repayments by consolidating your debts only to cost yourself far more in the long run do you?
Stick to the tip above and repay your consolidated debt at an accelerated rate. This will ensure you are charged less interest and take full advantage of the lower interest rate.
The golden rule of consolidating debts into your mortgage
If you are going to consolidate your debts under your mortgage, you need to remember a few golden rules.
Quite often people consolidate their debts as they are under repayment stress. They are paying large amounts of interest and are struggling to keep up. Remember that by consolidating debt into your mortgage, you will free up cash flow and potentially save on interest in the short term, though unless you put a strategy in place to repay the consolidated debt at a faster rate, you are quite likely going backwards financially.
Remember that by consolidating other forms of debt into a mortgage, you are securing that debt with your property. This has implications in that if you can’t service your mortgage, the bank has the ability to use your secured property (e.g. sell it!).
Don’t risk your home. Play it safe and consider this before deciding what you want to do.
Alternatives to consolidating debts into a mortgage
Now if you don’t trust yourself to make higher and more frequent repayments to your newly consolidated debts, you might want to consider some other options.
A few strategies exist to manage multiple debts, however it all really depends on your financial situation. Nonetheless, the foundation of many of these strategies is to become aggressive when it comes to repaying debt.
I personally consolidated some of my wedding debt into the mortgage but only after I employed a few strategies of my own. I used the following strategies to help me lower my debt rapidly prior to consolidating (this meant I consolidated 40% less debt into my mortgage) which for me was far safer than the full original amount (due to my fears of making it a secured debt).
Firstly I used the debt snowball method to pay down as many debts as possible. I then got slightly angry after getting rejected for a credit card, leading me to engage all out warfare on my debts. Sometimes a bit of anger is great for motivation as it forced me to act and accept my problem.
Did putting your debts onto your mortgage help your or not?
If you are someone who has done this, we would like to hear from you. Did it work for you? Did you maintain the required amount of discipline to repay the consolidated debts and enjoy the interest savings? What would you do differently next time?