A debt consolidation mortgage is a type of mortgage refinance that allows you to use valuable equity that you have in your home to consolidate all of your high-interest debts into one low-rate mortgage loan. In essence, the process allows you to merge all types of debt, including mortgages, credit card debts, credit lines, car loans, student loans, tax arrears, etc. into one loan that is backed by the equity in your property and is payable in easy and manageable terms.
There are three ways you can use your home to consolidate your debt:
You could refinance your mortgage into a new loan that offers better terms and use the additional cash to pay off other debts. Through a refinance you will have to end your mortgage term early and consolidate your mortgage and other debts into one loan for up to 80% of your home’s value (Loan-to-Value ratio, LTV). Ending the mortgage term early means that you are breaking the terms of the contract, so you will be charged penalty fees. Charges will vary depending on the mortgage amount and terms, it can either amount to three months’ interest if it is a variable mortgage or it can add up to a hefty interest rate differential penalty with a fixed mortgage.
Home Equity Line of Credit (HELOC)
A HELOC is a line of credit that is backed by your home which you can access as needed until you reach your credit limit. A maximum loan balance is first established which is set up to 80% of your home’s value, minus any outstanding mortgage balance that the home still has. Once a credit limit is set, you can withdraw as much or as little on the line of credit at your discretion. All HELOCs are considered variable rate mortgages. Rates are usually based on current prime rates. Minimum monthly payment is an interest-only payment based on the amount you have withdrawn, so you are not required to pay a portion of the principal amount each month. There can be hefty legal fees associated with adding a HELOC on top of your first mortgage, but in some cases this can be a better option than incurring costly refinancing penalties.
A second mortgage is another debt consolidation option that allows you to use the equity in your home to borrow money up to more than 80% of its value. This type of mortgage loan is considered a subordinate mortgage to the original mortgage, so the loan amount is usually lower and the interest rate is usually higher than the first mortgage. Although they come with higher interest rates, the rates are still significantly lower than those of credit cards and personal lines of credit.
Why consolidate debt?
Debt consolidation makes very good financial sense if you are in a situation where it is nearly impossible to make full monthly payments on time on your high interest debts such as credit cards, auto loans, or other consumer loans.
By consolidating your debt you are able to:
- Lower your monthly payments – The extended amortization/repayment period that a debt consolidation mortgage may offer will allow you to pay less each month, leaving you with extra money left over which you can either use to make additional payments to your consolidated loan or add towards your monthly household budget.
- Lower your interest rate – Because a debt consolidation mortgage is backed by the equity in your property, lenders can reduce the amount of interest you would have to pay. Additionally, mortgage loans in the finance world will always carry the lowest interest rates, as opposed to credit card charges for instance. This is because there is an asset to back up the loan. With your credit card debts, you pay about 15% interest charges, while the average on a mortgage loan is only about 3%. That’s an astonishing difference altogether.
- Improve your credit score – With lower monthly payments and lower interest rates, you are more likely to make monthly payments on time and in full. This will allow you to rebuild your credit and eventually improve your credit score, which will give you better options to borrow money in the future.
If you’re a homeowner with equity available in your property, then a debt consolidation mortgage is another option to help you manage your debt and reorganize your finances.