Debt is a stark reality that the majority of us face on a daily basis. Credit cards, a line of credit and auto loans are the most common examples of debts with high interest rates. Some of these rates reach a staggering 29%. These obligations will have you running on a treadmill that keeps you working hard to meet expensive minimum payments – without ever going anywhere. This is discouraging at best, and at worst, this seemingly hopeless slogging can keep you from meeting your financial goals.
If you’re a homeowner, you have the benefit of having additional options that can help you manage your debt. A debt consolidation is a transaction that allows you to combine all of your debt into one loan – that loan is your mortgage. Refinancing your mortgage gives you access to “cheaper” money, which is money loaned to you at a lower interest rate. You can then use this low-interest “money” to pay off your debts by building them into your mortgage.
This is called a debt consolidation mortgage, and it’s a great way to lower your interest rates so that you can step off of the treadmill and actually move forward by paying down your principle. Last year 10% of Canadians refinanced their mortgages, and 62% of them cited debt consolidation as the reason for their decision. Aside from lowering interest rates, making a single monthly payment to your debt consolidation mortgage is much easier than dealing with various payments to a scattered group of lenders. In most cases the lender will allow you to keep your credit lines & cards open. These long-term credit accounts are important to building a strong credit score, closing them would have an immediate negative impact.
Like most mortgages, a debt consolidation mortgage will come with flexible pre-payment options. You may be allowed a 20% pay down of your principle without penalty. In other words, you can stop throwing your hard-earned money against a wall of interest rates, and start paying down what you actually owe. You can also extend the time period over which you would like to pay your loan, in order to make your monthly payments more manageable.
Of course, making your life easier always comes with a cost. Consolidating your debt means you must break your current mortgage in order for your high interest debt to get repaid by (or amortized into) the new mortgage at a lower rate. As a result your overall debt will go up as you pay to break previous terms of loans, or perhaps shell out a CMHC premium on the increased balance of your new mortgage. The rate of interest you pay overall goes down – but those high interest debts are now being paid off over much longer periods of time giving you the benefit of more cash flow & less stress.
This is why it’s essential to tackle your debt issues quickly. A debt consolidation is for long-term thinking, as opposed to short-term impulses. If you decide to commit to a debt consolidation mortgage, you should probably do so before your high-interest debt get too excessive and you run out of options. Credit problems, a poor credit history, or simply too much debt, can all cut you off from the possibility of consolidation.
If your application for consolidation is accepted, the most important issue to consider is whether or not you’ll get back into the habit of spending more than you earn, creating a vicious cycle. Once you refinance your home, what do you do the second time you rack up too much debt? Consolidation of debt is a long-term strategy. If you make a commitment to debt consolidation, you can step off of the treadmill, but you also have to step away from the short-term thinking that caused you to run a deficit. It wouldn’t make sense to step off that treadmill and into a noose that will slowly tighten around your neck. Take advantage of how a debt consolidation mortgage can facilitate the planning of your monthly budget, to help you start living within your means.