Using a mortgage or HELOC for debt consolidation can save you money in the long term since you pay less interest.
It's challenging to handle your finances when you owe multiple high-rate debts such as credit cards or loans. However, if you're a homeowner, you may use the equity in your house to your advantage.
Paying off debt with a consolidation mortgage or home equity line of credit (HELOC) will generally help lower the interest paid. However, there are sometimes hidden fees or circumstances where consolidation does not make sense. This article will provide an in-depth overview of debt consolidation.
Debt consolidation is the process of combining several high-interest rate debts into one low rate loan. High-interest rate debt includes things such as credit cards, payday loans, and other non-mortgage balances. In general, these debts have an interest rate of around 20%, meaning a $10,000 balance would cost $2000 of interest every year. By shifting the high-interest debt to a low-interest loan (such as a mortgage or HELOC), borrowers can refinance to the low rates seen below.
The interest rates are lower for a HELOC or mortgage because your property secures them. This means you must have sufficient home equity to qualify. The following section explains the process in detail.
To qualify for a debt consolidation loan, you must have home equity. Equity is the difference between the value of the home and what is owed on the mortgage.
Let's say your property is worth $200,000, and you owe only $125,000 on your mortgage. As a result, you have $75,000 in equity. Your home equity continues to rise as the property value increases, and you pay off your mortgage debt.
Consolidating debt into a mortgage means refinancing your existing mortgage and rolling high-interest debts into a new mortgage with a lower interest rate. A popular way to do this is using a readvanceable mortgage.
Typically, you can only refinance up to 80% of the property value, which would be $160,000 ($200,000*80%) in our scenario. This would provide the borrower with an additional $35,000 (160,000-125,000) of cash to pay off high-interest debt. As a result, the borrower has effectively switched multiple high-interest debts into one low-interest debt.
However, there are fees associated with refinancing, such as the cost of breaking the old mortgage along with administrative expenses. The upside is that you will be saving the money that otherwise would've been spent on high-interest rate debt.
A home equity line of credit or HELOC, is comparable to a mortgage in most respects. It's registered against the title of your property and is secured by its equity, just like any other mortgage. The primary distinction is that it's a revolving line of credit.
Instead of receiving a set amount of money, home equity loans allow you to withdraw cash as needed. You may also pay it down as quickly as you like.
For example, you might use your HELOC to pay off your other debts and consolidate them into the line of credit. However, instead of making lower payments as you would on a regular mortgage, you may make larger monthly payments and pay off the debt faster. Most loans have early repayment penalties; therefore, it isn't always an option in those instances.
There are many factors to consider when determining if a debt consolidation mortgage is right for you. Some of the primary parts include:
You'll want to consider these things, as well as any other circumstances that might come up to honestly know if refinancing your mortgage and reducing your de bt is the best option for you. If you want to know precisely how combining your debt with payments on your mortgage will affect you, you should consult with your bank or credit union first.
The big banks in Canada have the strictest lending criteria. They'll look at your credit score, income, monthly cash flow, and a variety of other variables when qualifying you for a loan.
Some lenders may be more flexible when assessing you for a HELOC. This is because many HELOCs only require interest payments every month. This decreases your monthly payments, which gives the lender more flexibility when analyzing your risk profile.
If you have bad credit, you'll have the best chance of being accepted for a second mortgage. Many private second mortgage lenders focus on customers with poor credit histories and lower credit scores. The downside is you’ll likely be charged a higher interest rate than a typical mortgage refinance.
However, there is no guarantee you'll qualify for a consolidation mortgage. Lenders assess many variables to determine your eligibility. This includes the appraised value of the property, how much debt you're seeking to combine into your mortgage, the amount of equity in the house, and your credit score.
There are several advantages to consolidating your unsecured, high-interest debt into your mortgage. This could reduce your monthly bills by a few hundred dollars throughout your loan.
It also has disadvantages, such as:
Debt consolidation is debt relief that consolidates debt into one monthly payment. Debt consolidation may be a great option for you because debt payments can be set up to be consistent and predictable. You also make one lower monthly debt payment instead of many like before. Additionally, you can also save money on interest!