Should You Refinance Your Mortgage As A Homeowner Debt Consolidation Loan
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, its 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?
How Debt Consolidation Loans Work
To start consolidating debt, apply for a personal loan through your bank or another lender. Once your lender approves you for a debt consolidation loan, it may offer to pay off your other debts automaticallyor you will take the cash and pay them off yourself.
After your pre-existing debts are repaid with your new debt consolidation loan funds, youll make a single payment on your new loan every month. While debt consolidation often reduces your monthly payment, it accomplishes this by extending the loan period of the consolidated loans. Debt consolidation also streamlines payments and makes it easier to manage finances, like having a single monthly payment due date.
When Does Debt Consolidation Make Sense
Its usually a good idea to undergo debt consolidation before you begin to experience real problems. If you wait until you start skipping payments or making them late, youll likely have already damaged your credit score.
And that means youll probably have to pay a higher interest rate on your debt consolidation loan. Leave it too long, and you might lose a lot of the savings you stood to make if youd acted earlier.
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Five Steps To Refinancing With A Debt Consolidation Loan
Ready to consolidate your debts by refinancing? First, you need to know what to expect.
Step 1. Make sure it’s the right option for youBe clear about why you want to refinance. Ideally consolidating your debts means better management of your finances. But If youre looking for an easy way out of credit card debt, you may want to re-think your spending habits.
Step 2. Work out all the costs involved with your existing debtsTo make sure refinancing is worthwhile, you’ll want to understand all the costs involved with each existing loan. Write down your individual repayment amounts, loan interest rates and all the fees associated with your current debts.
Step 3. Find out how much you can borrowOnce youve calculated the combined total of your loans, check youll actually be able to borrow the amount you need. As a first step, it is a great idea to speak with your current home loan provider as they may be able to review your mortgage and offer you a better deal. To get you started, use our borrowing power calculator to find out how much you could possibly borrow.
Step 4. Compare different loansIf you decide to switch to a new home loan you need to make sure youre really getting a better deal because the idea is to save money and pay off your debts. Look for a combination of low interest rates and minimal fees. If offset accounts and redraw facilities are important to you, make sure theyre available with your new loan.
Optimize Your Loan Term
Getting a loan with a lower interest rate and a longer term can reduce your interest rate and lower your payment. However, too long a term could cost you more, even if the rate is lower.
For instance, if you owe $5,000 on a credit card with a 17% interest rate, and your minimum payment is $100 per month, it will take 79 months to clear that debt and cost you $2,896 in interest. If you refinance it to a 15-year home equity loan at 10% interest, your payment drops to $53 a month. But it will cost you $4,671 in interest by the time you pay it off.
So, you want to optimize the term of your new loan to suit your needs. You want it to be short enough to pay off within a reasonable period. But you dont want it to be so short that youll struggle to make your monthly payments. One solution is to take a loan with a payment you can make easily but then pay it down as fast as you can.
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How Does Credit Card Debt Affect Getting A Mortgage
may help to improve your credit score over time, sometimes the popular form of credit can negatively affect your chances of achieving a successful home loan application.
A higher credit card limit can indicate that you may be a liability in the future, especially when an average monthly minimum repayment is calculated based on the upper limit. The higher the repayment required, the harder it may be for you to meet your other financial obligations. Using several credit cards at one time may not be viewed favourably either, with risk increasing for the lender with each additional card.
Debt Consolidation Mortgage Worst Case Scenario
In a worst-case scenario, a homeowner could refinance their debts then run up new debts so high they can no longer afford monthly mortgage payments. They could face foreclosure and eventually lose their home.
Its also important to remember a mortgage refinance involves resetting your loan term. If you were 10 years into a 30-year mortgage at the time of refinance, your remaining term would reset from 20 to 30 years.
This means youll be paying interest for an extended period of time. So despite short-term savings on your higher-interest debt, you could end up paying more when all is said and done.
Overall, a debt consolidation refinance can be a smart way to pay down debts at a much lower interest rate. But it requires a high level of discipline in making payments to avoid negative consequences.
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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 homes 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 .
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.
May Encourage Increased Spending
Similarly, paying off credit cards and other lines of credit with a debt consolidation loan may create the illusion of having more money than you actually have. Its easy for borrowers to fall into the trap of paying off debts, only to find their balances have climbed once again.
Make a budget to reduce spending and stay on top of payments so you dont end up racking up more debt than you started with.
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Whats The Difference Between Refinancing Vs Renewing Your Mortgage
Renewing your mortgage means staying with your current lender for another term. Youll have an opportunity to renegotiate your interest rate and term, and you wont need to re-apply.
When you refinance, you are paying out your existing mortgage in order to negotiate a new mortgage loan agreement. This is usually because you want to access the equity in your home or lower other borrowing costs. There may be prepayment charges depending on when you choose to refinance.
Signs You Should Consolidate Debt
- You are spending more money than you are making.
- Your credit card balances are growing, not shrinking.
- Youre paying only the minimum payments on your debt
- You have been turned down for a credit card or store installment loan for having a high debt-to-income ratio.
- You carry debt on more than 5 credit cards.
- You are approaching or are at your credit card limits.
- You carry a balance on credit cards with interest rates in excess of 18.99%.
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Consider The Cost To Refinance
Before you decide on refinancing your TD Mortgage or a TD Home Equity FlexLine, be sure to look at all potential costs. Prepayment charges may apply if the agreement is ended before the term is done. There may also be associated fees for mortgage registration and property valuation.
But if youre able to take advantage of lower interest rates, your overall savings may make it worthwhile.
How Refinancing Your Mortgage Can Help You Pay Off Debt
When you refinance a mortgage to pay off debt, one of the main benefits is youll pay less in interest costs. Mortgage rates are much lower than rates on other consumer products like credit cards, personal loans, and private student loans.
How you use a refinance to pay down your debt depends on whether you do a rate-and-term refinance or a cash-out refinance.
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Pre-qualification option available to see if you’re eligible before applying.
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- Repayment terms: 36 to 72 months
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Do Balance Transfers Hurt Your Credit
Opening a new credit card and using a balance transfer to pay off existing credit card debt may also lower your credit utilization ratio. However, a balance transfer card is still a revolving account. A debt consolidation loan might reduce your utilization ratio to 0% . A balance transfer to a new credit card won’t have the same effect.
So, a could potentially improve your credit scores. But in general, paying off revolving credit cards with an installment account has a chance to improve your scores more.
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Remember The Closing Costs
Keep in mind that refinancing comes with closing costs, just like your original mortgage did.
These costs often total 2-5% of the new loan amount so look for an interest rate low enough that youll be able to recoup the up-front cost while saving on your external interest payments.
Your cash-out refinance costs can often be rolled into the loan amount, as long as theres enough money leftover to pay off the debts you were hoping to consolidate.
How Does A Debt Consolidation Loan Work
A debt consolidation loan works just like any other type of loan. But in this case, once youve been approved youll use the money you receive to pay off any high-interest debt you have. This can be credit card debt, personal loan debt, and any other type of debt that is eligible. Keep in mind that certain types of debt, think car loans and mortgages, cannot be paid off with a debt consolidation loan.
Check out this guide on loans in Canada.
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Cons Of Debt Consolidation
- If you decide to consolidate debt with a home equity loan, a home equity line of credit or a cash-out refinancing, you put your home up as collateral, which means it could be lost to foreclosure if you can no longer afford the monthly loan payments.
- If you choose a personal loan, it may take a long time to process.
- Fees can add up.
- Your credit score may not qualify you for the best rates.
- You will be paying on the loan for 3-5 years and if you cant stop, or at least slow down your credit card spending, you may be stuck again.
Do I Need Good Credit To Consolidate Debt
Applicants with good credit will have a wider range of debt consolidation options. They can get approved more easily for balance transfer credit cards with introductory 0% APR periods and personal loans with lower APRs.
Still, there may be options for consolidating debt if you have bad credit. You could try a secured loan, such as a home equity loan, which may come with a lower APR. There are also 401 loans, which let you borrow money from your own retirement fund without a credit check.
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Tips For Comparing Personal Loans For Debt Consolidation
Personal loans often are available online through traditional banks, credit unions and alternative lending platforms so you can apply quickly and conveniently, without having to visit a bank branch. Many of these lenders also offer competitive interest rates and flexible repayment terms, meaning you may be able to save money by consolidating your other debts.
Consider these tips when comparing personal loans:
Should I Refinance If Interest Rates Are Low
When interest rates fall, the possibility of getting a lower mortgage rate is a strong reason to consider refinancing if you need additional funds. A reduction in your mortgage rate could lead to significantly lower monthly payments.
However, you must factor in the costs of ending your current mortgage, including any prepayment charges, as well as how long you expect to live in your home. Only then can you determine whether its worthwhile to refinance at a lower rate.
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What Else To Consider When Consolidating Your Debt
- Itâs a good idea to check that your credit card has been cancelled after settling your debt consolidation loan so that you donât accrue more debt
- To ensure that a debt consolidation loan is right for you, itâs important that it is well-structured. A poorly structured loan could have you paying more in interest than you would if you hadnât consolidated your debt
- Consider what loan term you want to place on your consolidated debt. If you choose a loan term that is too long, you may end up paying more in interest than you would have if you hadnât consolidated.
To find out if debt consolidation is the right move for you, have a chat with a Lendi Home Loan Specialist for free expert advice.
The Pros And Cons Of Refinancing
|Pros of refinancing||Cons of refinancing|
|Access the equity youve built up in your home.||Increasing the amount you are borrowing may lengthen the time it takes to pay off your mortgage.|
|Consolidate your debts and lower your overall interest rate.||Your overall interest rate might be lower but the amount owing on your mortgage may be higher.|
|Possibly get a lower interest rate and pay less for your mortgage over time.||There may be additional costs, including a prepayment charge.|
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The Risks Of Consolidating Your Debt
Consolidating or refinancing loans can work out well if it means paying less in fees and interest. But there are risks:
- It may be a short-term fix if we cant meet the repayments on the new loan.
- Lower repayments but over a longer term can add to the overall cost because were paying interest for longer.
- There can be extra fees and charges, including hidden fees for alterations, late payments and payment defaults. Believe it or not, lenders may even charge extra for paying off existing loans early.
- Companies specialising in debt consolidation may charge higher interest than a bank. Talk to the bank about what they can offer before signing up with a new company.
- There would probably have been establishment or documentation fees paid on the original loans. Taking out a debt consolidation loan adds another set of fees, which could cost hundreds of dollars.
To reduce the risks, find out the total cost of consolidating before signing up. Shopping around and reading all the fine print helps.
Borrowing to make ends meet or struggling with debt? Try our debt calculator.
What Does Apr Mean
The Annual Percentage Rate expresses the actual cost of the loan as an interest rate. The note rate is the interest rate base used to calculate payments. However, other finance charges are always added on. So the APR includes all charges to show what the actual cost of the loan will be expressed as an interest rate. The Truth-in-Lending form must disclose the APR.
Give me an example.
Say you take out a $200,000 loan with a 30 year term and a fixed interest rate of 7.5%. There are additional charges for closing, title, application and other items that total $5000. The $5000 will be spread out over the 360 payments and included in the monthly loan payment. Your monthly payments will be $1433.39. So if you calculate your interest rate in reverse based on the monthly payment, you will actually be paying the equivalent of 7.75% interest on the $200,000 loan amount.
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