Is A Debt Consolidation Mortgage Right For You?

Certified Mortgage Advisor
NMLS 1701021
Published 
September 11, 2019

Debt consolidation mortgage

So a debt consolidation mortgage is basically where you're going to pull into the equity of your home that you have right now to pay off some higher interest debt. So we're going to talk about some strategies there and how you can get rid of some high-interest credit card debt that you might've accumulated because of something that happened.

Or you're just in a spot where you're ready to get rid of that. And do you want to use your current mortgage to help you do that? So we're going to talk through first, what it is, some strategies you can take, and definitely what to avoid because a lot of people make a really big mistake.

What is a debt consolidation mortgage?

A debt consolidation mortgage is more commonly called a cash-out refund. So cash-out refinances are where you're refinancing your first mortgage and you're pulling cash out of the property. So when you bought the property, you probably put in down payment and then over a period of time, your equity has gone up because you've paid the loan balance down.

So what we do in a cash-out refinance is instead of bringing money to the closing table, you're actually pulling money out. So you do a refinance that helps you tap into the equity that you've already paid into the property from your down payment and some of those monthly payments that you've been paying over time.

And what you're doing with a debt consolidation mortgage is not eliminating debt, but you're taking your consumer debt. So things like credit cards, or maybe some loans and wrapping that into a new mortgage and what this does is helps you manage those payments differently. So instead of having your mortgage payment, plus maybe a couple of credit cards. Now you just have your mortgage payment and you take those credit card payments and all the credit card balances, and you wrap them into the mortgage amount.

So what happens then is when you close on your refinance at closing. Those credit cards are going to get paid off, or those loans are going to get paid off and you're going to have a higher loan mortgage balance because of that.

Consolidating for risk and cost

So why would we want to do this? Why would we want to take all the debt that we have and consolidated it? The first reason why, and this is the biggest reason why is we're going from high-interest unsecured debt to low-interest secured debt. So this is all about risk and costs. So for instance, if you have a mortgage right now, and then you also have a credit card, let's say you have a credit card balance of $10,000. For that $10,000, you're probably paying a high-interest rate, maybe around the 15 to 20 to 25% mark $10,000. You're paying a lot of interest on this money.

Also, this money isn't backed by anything. So if you don't have any cash available and you can't make payments on this, you're going to have to default on that card and not make any payments. So what happens with a mortgage though is a mortgage is a type of debt that has a lower interest rate. So by the time of this writing, we're seeing interest rates in the high 3% mark. So you're looking at 3% to 4% on your mortgage.

Then it's also secured, which means that this debt if you sold the property would go away. So in the event that you can't make those payments, you can always sell the property, and then that mortgage payment goes away.

Let's avoid risky situation

So that's the two differences between here is sometimes when we take on too much consumer debt and it has higher interest and that's not secure, it puts us in a more risky situation. So the reason we would want to do a debt consolidation mortgage is to take high-interest unsecured debt and convert it into low-interest secured debt.

Now the big problem here though is it smart to take short-term debt and converted into long-term debt. Because credit cards, you're not going to be paying on for 30 years, whereas a mortgage you might. So off the bat, it wouldn't be smart just to take this $10,000 and immediately throw it into the mortgage and not do anything with it.

Because then what we did is we took a credit card that could have been paid off. Let's say in seven to 10 years. And now we just stretched out that debt over 30 years. That's not what we want to do.

Eliminate your debt before you consolidate

So the smart thing to do to start eliminating this debt, if you're going to do a debt consolidation, the mortgage is to take the credit card debt, wrap it into the mortgage, and then continue to make payments similar to what you were making on the credit card.

This is going to accelerate that debt payoff so that your mortgage balance is going to become lower because the mortgage is absorbing this loan over here. And so we want to make sure that we're not just putting over the debt over on this side and forgetting about it because then we'll end up paying more interest.

And this is something that your mortgage advisor can help you do and figure out what kind of payments you need to make. And then what's going to be the difference with your mortgage compared to the debts that you had to begin with.

Limits for a cash out refinance

Something that you're really going to have to keep in mind is the limits for a cash-out refinance. For instance, let's say you had a $200,000 property. So your house is worth $200,000. And let's say that you've paid down your mortgage balance to let's say $125,000. So that spread in there is $75,000. So when you go to do a debt consolidation mortgage, you're not going to have access to that full 75%.

You're only going to have access to about 80% of that money. If we took 75,000 times 80%, that's going to give us a $60,000 that we have available to pull in as a cash-out. Now, obviously, we don't want to pull out all of that money. You only want to pull out the money that you're using for debts there.

So something to keep in mind, that you can do an easy way to find this is going ahead and looking up the current value of your property. If you need to contact a realtor, that's something that you can do. Also, you can let me know and I can pull up the value of your property right now. We can take that time 0.8. And that's going to show us you available loan amount that we can take.

Then what we'll do is we can add your first mortgage plus any amount that you'll be paying in debt consolidation. And as long as we're below that 80% mark, then you're good to do a cash-out refi.

Don't think it's a solution to your debt problem

Also a cash out refinance is not a solution to a debt problem. So if you have a problem with debt, think about how you got this credit card or this consumer debt in the first place. If this is an ongoing problem, something that you feel like is going to continue, then I wouldn't do a cash. Refinance to consolidate some of this debt because it's not going to solve the problem that's existing there in the first place.

It is only a temporary solution

If you have a problem with spending, and if you do then start looking into ways that you can help manage a budget and navigate some of that spending and really tailor back a little bit of your lifestyle. That way, this doesn't become an ongoing problem. So if you got the debt in the first place from business expenses or healthcare or tuition, or maybe some one-time bigger expenses that you're looking to just finally get rid of, then a debt consolidation, mortgages can be fantastic.

But if it's just from discretionary spending, or clothing, or just personal items. It's probably not going to be the best solution because a debt consolidation mortgage takes a little bit of planning, takes some commitment to a specific lifestyle of paying off debt as quickly as possible. It's not a solution to just take your debt, throw it into a mortgage and forget about it.

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