Between credit card debt, car payments and other loans, personal debt can quickly become overwhelming. Making multiple repayments across all your debts each month can put a strain on your household budget, and make it difficult to cover unexpected expenses for life’s little surprises. In addition, unsecured debts such as credit cards tend to attract high interest rates, costing you a significant amount of interest over the life of your debt.
If you’ve ever asked yourself “Can I consolidate my debt with a home loan?”, the answer is yes. If you’re a homeowner who is juggling multiple debts, a debt consolidation home loan may be an attractive opportunity that could potentially save you thousands.
What is debt consolidation?
Debt consolidation is a financial strategy which allows you to roll multiple debts into one larger loan, typically with a lower interest rate.
For example, if you owe:
- $2,000 on a credit card
- $10,000 on a personal loan
- $12,000 on a car loan
All three of these debts are likely to have different interest rates, loan terms and monthly repayments. By rolling all three debts into a single, debt consolidation loan with only one repayment, you can potentially reduce your monthly repayment amount and take advantage of more competitive interest rates and loan terms.
How does refinancing your mortgage allow you to consolidate your debt?
Refinancing your current mortgage presents a unique opportunity to not only secure better loan terms, but also to consolidate your other existing debt. You may also choose to increase your existing home loan to consolidate debt.
If the amount of usable equity in your property is higher than the balance of your other current loans or debts, you may be able to borrow against the equity in your property to secure a larger home loan and use the funds to pay off your other debts.
For example, if you owe $300,000 on your mortgage, you have built up $50,000 of home equity and have $24,000 in existing debts, you may be able to secure a new home loan with a balance of $324,000:
- $300,000 will be used to pay off your old mortgage
- $24,000 will be used to pay off your existing personal debts.
This means that you will have only one repayment and loan term to manage instead of multiple different loans.
How do I calculate my home equity?
If you’ve owned your home for a few years, it’s likely that you have built up usable equity. Home equity can be a powerful financial tool.
- Home equity is the difference between the market value of your home and the amount owing on your current home loan.
Most lenders will require you to have at least 20% equity remaining in your home if you’re planning to refinance*. This means that unless you’re planning to sell your home, your usable equity should be calculated as 80% of the market value of your home, less the amount owing on your home loan.
For example:
If you own a home with a market value of $500,000, and you owe $320,000 on your mortgage, the amount of usable equity you may be able to access for debt consolidation is $80,000.
*Some lenders will allow you to refinance with a Loan to Value Ratio (LVR) higher than 80%, however Lenders Mortgage Insurance (LMI) may apply.
Is debt consolidation into your home loan a good idea for your situation?
While it’s important to consider seeking professional advice before consolidating your debt, there are some things you should consider to help you decide whether using your home loan to consolidate your debt is a good idea for your unique financial situation.
Do you have enough usable equity in your property?
If your home’s usable equity is higher than the combined balance of your existing personal loan or credit card debt, you may be a good candidate for debt consolidation.
If the combined balance of your personal debts is higher than the amount of usable equity in your home, refinancing your mortgage may not be the best way to consolidate your debts. You could consider waiting a few years to build up more equity in your property or consider other options for consolidating debt.
Some lenders will still allow you to refinance your mortgage and consolidate debt with an LVR higher than 80%, but you should consider whether this will still help you save money after considering LMI fees and the higher interest rates than may apply to loans with a high LVR.
Could you benefit from a lower interest rate?
One of the key advantages of using a mortgage to consolidate debt is that home loans generally have much lower interest rates than credit cards or other unsecured debts. If you’re paying only the minimum payment on a credit card, you will pay significantly more interest over time than if you consolidate that debt into your home loan.
Would you like to simplify your monthly repayments?
Having multiple repayments for each of your debts can be a hassle. When you consolidate your debts into your home loan, you can entirely pay off your old debts. Instead of tracking multiple due dates and different interest rates, you’ll have just one consistent monthly or fortnightly payment to manage.
Spreading out your debts over the longer term of a home loan can also result in lower monthly payments, improving short-term cash flow and helping you get ahead.
What kinds of personal debts can be consolidated?
When consolidating your debt using your home loan, you can consolidate things like:
- Credit card balances
- Personal loans
- Car loans
- Overdraft facilities
- Store credit card balances
Some types of personal debt may have specific rules and guidelines for whether or not they can be consolidated. Student loans and government-backed loans may not be available for consolidation with all lenders.
Are there disadvantages to consolidating your debts?
While debt consolidation can be extremely helpful for some homeowners, there are some potential risks and disadvantages to be aware of.
Risk of accruing more debt
If you use a debt consolidation home loan to streamline existing loan or credit card debt without changing your spending habits, you risk accumulating more debt in the future.
Higher home loan balance
By increasing the balance of your home loan, you’re reducing the equity you hold in your property. This can impact your ability to use your home equity for other purposes, and reduce the amount of money you stand to make from any future house sale.
Potential fees and charges
Especially when consolidating multiple debts, you should consider the fees and charges which may apply to not only your refinance, but also your other debts. Potential fees and charges to be aware of include:
- Discharge fees
- Application fees
- Lenders Mortgage Insurance (LMI)
Before consolidating debt, shop around different lenders to find the best product for your financial situation. Some lenders, such as Homestar Finance, can save you money by discounting or eliminating common charges, including application fees, offset account fees and ongoing monthly fees.
Summary
Consolidating personal debts using home loan refinancing offers an opportunity to streamline your finances and take advantage of more attractive interest rates and loan terms. While this strategy can provide benefits such as improved cash flow and simplified debt management, you should carefully assess your unique financial situation and long-term goals to decide if debt consolidation is the right choice for you.
This information is general in nature and has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness of the information and if necessary, seek appropriate professional advice.
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