Debt Consolidation Mortgage
Debt consolidation is the process of combining multiple existing loans into a single loan with the most favorable terms. Debt consolidation lenders can help reduce interest rates, extend payment terms, and lower monthly amortization.
Consumers and small business owners typically use debt consolidation to pay off high-interest debts like credit cards, lines of credit, student loans, and other short-term loans. In most instances, this involved refinancing the current mortgage or taking out a home equity line of credit.
What is a Debt Consolidation Mortgage?
A debt consolidation mortgage is when you take out a larger, long-term loan using the available equity in your property to pay off your existing unsecured, high-interest debts all at once. This allows you to consolidate several debts into one, leaving you with just one loan to monitor, manage, and pay over time.
With a debt consolidation mortgage, a structured payment plan is provided, making it a lot easier to keep track of your amortization requirements until the loan is paid off. Since a debt consolidation mortgage is backed by your asset as collateral, it usually offers a more favorable interest rate compared to other short-term, unsecured loans.
When to Consider Debt Consolidation Mortgage
If you are overwhelmed and tired of managing different debts and coordinating with several creditors, debt consolidation may be the right solution for you.
Debt consolidation is a better option if you find the original terms of your existing loans are no longer convenient. You may want to consider consolidating your debts if you prefer a loan with a lower interest rate, or if you want to extend your payments for your current short-term debts.
If maintaining multiple outstanding short-term loans is getting difficult, debt consolidation will make you manage just a single loan and deal with just one creditor.
Your Circumstances Have Changed
The best time to consolidate your high-interest debts is when you are a better applicant for a loan than you were in the past. For instance, your personal credit score has significantly improved since the last time you applied for a loan. Also, if your business profitability or personal income has increased, you have a better chance of getting qualified for debt consolidation.
You Have Enough Equity in Your Property
It’s best to consider a debt consolidation mortgage if you have enough equity in your home to cover your other debts. Your home equity is the portion of the property that you own. It is the difference between the value of your home and the mortgage balance that you owe to the lender. Your home equity can increase over time as you pay down your mortgage and as your property goes up in value.
How Much Home Equity Do You Need?
Most lenders would agree to lend up to 80% to 90% loan-to-value (LTV). Ideally, you should not owe more than 80% of your home’s value after the debt consolidation because lenders would often require mortgage insurance for loans with more than 80% LTV.
- To avoid the additional cost of insurance, it’s important to know your loan-to-value ratio before refinancing your mortgage to pay off your other debts.
- To calculate your LTV ratio after the debt consolidation, add your current outstanding mortgage balance and the total amount of debts you want to pay off, then divide the sum by your approximate home value.
See the formula below:
LTV ratio after debt consolidation =
(Current outstanding mortgage balance + total debts you want to consolidate) /
approximate home value
For example, let’s say the approximate value of your property is $200,000. Your outstanding mortgage balance is $130,000. You want to consolidate a total of $20,000 debts. Using the formula above, your loan-to-value ratio after debt consolidation is as follows:
($130,000 + $20,000) / $200,000 = 75% LTV
In this scenario, your LTV ratio is 75%, which means you have enough home equity to pay off your other debts without having to buy mortgage insurance.
Aside from your available equity, lenders will often need to consider other factors in deciding how much money you can borrow, such as your credit history, current income, and total debt-to-income ratio. These deciding factors may vary from one lender to another.
Why Would You Consider a Debt Consolidation Mortgage?
A debt consolidation mortgage is a great option if you are a property owner who has enough home equity to pay for your other high-interest, short-term debts like credit cards and unsecured personal loans. There are several reasons why you would want to pay off your consumer debts using a debt consolidation mortgage, including the following:
- You want to lower your debt servicing cost. Most credit card debts and personal loans are unsecured, which means there is no collateral to back the loans should the borrower fail to pay. Unsecured loans typically have higher interest rates compared to secured loans. With a debt consolidation mortgage, your new interest rate will be lower than the current interest rate you are paying for these debts, reducing your overall monthly debt servicing costs.
- You want to lower your monthly amortization. Debt consolidation is also a good option if you want to extend your payment terms, since most mortgages offer longer payment terms compared to credit card debts and personal loans. With extended payment terms, your monthly amortization will be significantly lowered, allowing you to manage your finances more efficiently.
- You will not run up your credit cards again. If you have a large amount of credit card debt because of unexpected expenses, like medical bills and other emergency expenses, a debt consolidation mortgage is a good solution.
- You want to manage only one debt. It can be stressful and exhausting to deal with multiple lenders and monitor different liabilities. Debt consolidation is a good option if you want to manage and pay only one debt at a time.
3 Types of Debt Consolidation Mortgage
If you have sufficient equity in your home, you can get rid of multiple high-interest debts through the following types of debt consolidation mortgage:
Cash-out refinance is where you take out a new, larger loan that pays off the old mortgage. You get the difference between the refinanced loan and your original outstanding balance as cash. You can use the money that you get from cash-out refinance to pay off your other debts.
2.Home Equity Loan
A home equity loan works as a second mortgage on your real estate. You can use your equity in your home as collateral to secure a new loan to pay off your other high-interest debts.
3.Home Equity Line of Credit
A home equity line of credit (HELOC) is a revolving credit line that offers an adjustable interest rate. It is similar to a second mortgage like in home equity loan but works more like a credit card. With HELOC, you can draw funds from your credit line to pay off other debts, and your property serves as collateral. You can decide when and how much money to draw as long it doesn’t exceed your credit line.
How to Qualify for a Debt Consolidation Mortgage
Lenders use several factors to check if a borrower can qualify for a debt consolidation mortgage, including:
- Credit score – You are more likely to get qualified for a debt consolidation mortgage if you have a good credit rating. Ideally, a credit score of 680 or higher is required so you can get the most favorable terms for your mortgage.
- Home equity – You should have enough home equity to cover your other debts. Typically, lenders can let you borrow up to 80% to 90% of your property’s value. If your loan-to-ratio value is more than 80%, the lender may require a mortgage insurance.
- Debt to Income Ratio – Debt consolidation lenders will check your debt-to-income ratio to make sure that you have the financial capability to pay your amortizations. If you have a high DTI, then read our article on high DTI mortgage options.
The documentation requirements may vary for each lender, but they will typically need a copy of your credit report, proof of income, and statements of the debts you wish to consolidate. The types of debts that you can consolidate include credit card debts, auto loans, personal loans, and student loans.
The Best Debt Consolidation Lenders
There are many lenders who offer debt consolidation mortgage programs. However, determining the best debt consolidation lender is not easy because there are so many factors that would decide who is the best. Plus, it may vary depending upon your specific situation.
The best debt consolidation lenders offer the following:
- Allow for credit scores as low as 500
- Will allow for a maximum LTV of at least 85%
- Will approve high debt to income ratios as high as 50%
- Will have competitive interest rates
- Will not charge fees that are over and above what is standard and customary
Pros & Cons of a Debt Consolidation Mortgage
A debt consolidation mortgage is a good solution to multiple high-interest debts, but it also comes with its own benefits and drawbacks and may not be recommended for everyone. Here are the pros and cons of a debt consolidation mortgage:
- You will enjoy a lower interest rate because you secure the loan with a mortgage.
- You can have a longer and better repayment term.
- Your monthly amortizations will be lowered.
- You will have a structured payment plan with a fixed end date.
- You will have better cash flow management because you only need to manage one account and payment due date.
- Paying off your high-interest debts can lower your debt servicing costs.
- When managed correctly, your credit score will improve in the long run.
- You will qualify for a tax deduction if your consolidation loan is secured with an asset.
- It may take time and effort to apply for a new mortgage.
- You could end up paying back longer than you originally planned as most mortgages are structured to pay off in 15 to 30 years.
- You make your property as collateral and you run the risk of facing foreclosure should you fail to pay back the loan.
- You may not get the best terms if you don’t have the best credit.
- You may incur additional costs such as closing fees, origination fees, and mortgage insurance, which may either be collected upfront or added to your loan amount.
- It may negatively impact your credit score at first because credit scores favor long-standing debts with more consistent payment history.
- It’s a temporary solution to a problem, which is the debt itself. If you have problems with managing your cash flow, you may run into the same situation again where you will use credit cards or borrow money for your living expenses.
Debt consolidation mortgages are a good option to pay off multiple high-interest debts so you can manage just one loan. However, when you use a debt consolidation mortgage to pay off other high-interest loans, you are using your property as collateral. While you will be free from other debts, your mortgage balance is increased by the amount of other debts you’re paying off. You are also putting your property at risk of foreclosure if you fail to pay back the loan.
Before you decide to consolidate your debts with a mortgage, it’s important to have a plan in place so you can properly manage your finances and won’t get into unnecessary debt again. You also need to consider several factors, such as the length of the loan and the costs involved, to maximize the benefits of debt consolidation mortgage.
Home Improvement Loans – This article speaks to refinancing to cash out the money needed to pay for home improvements. This will allow you to consolidate all of the costs associated with your home remodel project into one convenient loan.
Cash out Refinance Options – Read about your various cash out refinance options not only for debt consolidation but for any purpose even paying for college tuition.