Is A Debt Consolidation Mortgage Right For You?

Certified Mortgage Advisor
NMLS 1701021
Published 
September 11, 2019

Lets avoid the mistakes with 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 gonna talk about some strategies there and how you can get rid of some high-interest credit card debt that you might have accumulated because of something that happened or you're just in a spot where you're ready to get rid of that debt. And you want to use your current mortgage to help you do that. So we're gonna talk through first, what are some strategies you can take, and definitely what to avoid because a lot of people make a really big mistake.

What is debt consolidation mortgage?

First of all, what is a debt consolidation mortgage? A debt consolidation mortgage is more commonly called a cash-out refinance.

What is cash out refinance?

So cash out refinance is 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.

How cash out refinance work

So what we do in a cash-out refinance is instead of bringing money to the closing table, you actually pull 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, and some of those monthly payments that you've been paying over time.

Wrapping your debt to the mortgage amount

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. All the credit card balances, and you wrap them into the mortgage amount.

Effect of debt consolidation mortgage

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 gonnaget paid off and you're gonna have a higher loan mortgage balance because of that. So why would we want to do this? Why would we want to take all the dent that we have in consolidating it?

High interest secured debt to low interest secured debt

The first reason why? And this is the biggest reason why we're going from high-interest unsecured 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, you're probably paying a high interested rate, maybe around the 15 to 20 to 25% mark on $$10,000. So 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.

Mortgage has lower interest rate

So what happens with a mortgage though is a mortgage is a type of debt that has a lower interest rate. So now, we're seeing interest rates in the high 3% mark. So you're looking at 3% on three to 4% on your mortgage. And 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. So that's the two differences here. 

Sometimes when we take on too much consumer debt and it has higher interest and that's not secured, it boots 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.

Is debt consolidation worth it if it becomes long term debt?

Now the big problem here is, is it smart to take short-term debt, and convert it into long-term debt, right? Because credit cards, you're not gonna 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 now, we just stretched out that debt over 30 years. That's not what we want to do.

Make payments as if you are still paying your credit card

So the smart thing to do to start eliminating this debt if you're going to do a debt consolidation 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 wanna 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.

Ask your mortgage advisor

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.

Cash out refinance limit

Something that you're really gonna 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 gonna have access to that full 75%. You're only going to have access to about 80% of that.

Let's calculate

If we took 75,000 times 80%, that's going to give us $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 wanna pull out the money that you're using for debts there.

So it's something to keep in mind what you can do an easy way to find this. Go ahead and look 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 away. We can take that times 0.8 and that's gonna show us the 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 refinance.

It's not an answer to your debt worries

Also, a cash-out refinance is not a solution to a debt problem. So if you have a problem with debt, you know, 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 is going to continue, then I wouldn't do a cash-out 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 mortgage is gonna 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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