Is using a mortgage consolidation loan a good idea?

More on Consolidation Loans

If you are a homeowner and can qualify for a home loan to consolidate your personal debt, you may be able to get a loan for the purpose of paying off your credit cards, automobile loans, and other debts.  You need to realize that this approach doesn’t actually pay off the debts in the loan.  You are really just relocating the debts to the mortgage consolidation loan and there is good and bad involved in that.

You could get a new first mortgage for this strategy, or you can do it as a new second mortgage which does not impact the terms on the current first mortgage.  Today it is harder to get a second mortgage and the rates are generally higher than on a first. You generally wouldn’t look for a second mortgage unless you can’t refinance your first, or primary, mortgage.

What are the positives for using a mortgage in a consolidation strategy?

1. You could get an improvement in your monthly cash flow right away. If this is done right, you should end up with a reduction in your overall debt payment thanks to a smaller mortgage payment. You aren’t making the payment on the debts you “paid off” in the new mortgage anymore (more on that later) which is where you’re saving money every month now. You should see a significant difference between payments on the new loan versus the old loan (plus the old debt payments) allowing you to save possibly hundreds of dollars a month or even more. You will find larger savings if you have significant amounts of debt. If you are not saving a significant amount of money thanks to the new mortgage payment you need to re-think what you are doing before you sign any loan paperwork.
2. You will see an improvement in the interest rate to be paid on your overall debt. Rates for a home mortgage are very low today. Credit card rates typically run much higher than mortgage rates, and it is a more expensive personal debt since it calculates based on compounded interest. Mortgages are calculated using simple interest which helps keep the debt from getting out of control as credit card debt often does.
3. Your tax write off or liability is generally improved. Your mortgage will most often bring you a generous tax write off. You will most likely not be able to write off any of the interest on your credit card debt. Your mortgage is larger right now and the amortization on a new loan is focused more on the interest than the principle. Your tax professional will be able to affirm your eligibility for tax deductions. They may also be able to show you where you can change your deductions and bring home more cash to go against your debt.
4. You would be wise to use the additional cash you have to attack your personal debt and pay it down faster. Not only can you pay down on your personal debt, but you can start paying down the mortgage and rebuilding your equity faster, too. Use that surplus cash to get that new 30 year mortgage consolidation loan paid off in 1/2 to 1/3 the time. This technique also helps you rebuild the lost equity in your home faster.

Now let’s look at the potential negative effects of using a mortgage loan for a debt consolidation strategy:

1. You are taking out a new mortgage loan that is larger than the one you had before. You have to make sure the new payment is affordable and that you can make the payment on time every month. That shouldn’t be a problem since you are saving money, having put some of your debts into the mortgage and offsetting those payments. Make sure the new loan strategy makes sense financially or you need to look for another option. The new loan is secured by your house which you don’t want to put at risk so make sure you completely understand the terms involved.
2. You need to know what the total costs are for the new mortgage loan you are taking out. High fees could mean the payment might not make sense. Be sure to double check everything before you move forward. If you aren’t getting an obvious benefit from it, don’t sign any paperwork until you have the deal that works for your budget and strategy.
3. Consolidating your debts in the mortgage can increase your all-inclusive personal debt load at the start. You might find that some loans don’t lower your payment enough to make it worth it. The new loan is not the better option for you if you are not able to gain enough cash flow to accelerate the pay down of your debts.
4. Even if your overall payment is lower, your spreading credit card and other debt payments out over the next thirty years. The cost of lower payments in the long run, is that you will pay more in interest since the term has increased.

What you need to know about consolidation loans:

1. Mortgage Consolidation loans have not historically made a huge contribution to improving the future of the homeowner. The risk to most homeowners is that they spend balances back on the credit cards that were just consolidated back into the mortgage.  This comes from a lack of financial discipline.  Moving your personal debt around has given you additional cash flow to use for your benefit.  However, debt has a way of sneaking back up on you when you least expect it and can easily wipe out your cash flow improvement if you are not disciplined.
2. Your mortgage brokers commission could be tied to the interest rate on your loan, and that has a direct impact on your new mortgage payment.  The higher your rate the more that they could make unless they are charging you a loan origination fee instead. In some cases, they get both an origination fee plus commission from the lender based on your rate.  It is very important that you read the paperwork in the initial loan quote and disclosures, and then read it again before signing so you know exactly what you are paying.  Don’t be surprised if you end up haggling with your mortgage company over the rate as it could be directly affecting the amount your mortgage company will make on the loan.
3. Many people will go for the loan option with the most cash out left over after “paying off” some debts.  What sounds good initially could hurt you in the long run as you are paying interest on each and every dollar you are pulling out.  And don’t forget that it’s coming out of your equity.
4. Be aware of any pre-payment penalties on your current loan.  This is very important.  You would not be the first person to end up losing at least several thousand dollars in equity due to a penalty on your current mortgage loan.  You should go through the old documents on your existing mortgage.  You would be surprised at the high percentage of people that don’t know they have an early pay off fee.  The place to check is in your current mortgage documents.
5. Make sure you are working with someone on your loan that is working in your best interest.  Getting a recommendation from your friends and your family is a good way to start off.  Make a list of the people that were recommended and look them up on the BBB (Better Business Bureau) website to see what their rating is. You have to work very hard to maintain a high rating with the BBB.

You have some good information on consolidation mortgage loans, now consider the following:

Getting a mortgage loan to consolidate debt does not pay anything off. Your mortgage just swallowed up the debts you rolled into it making it even larger. The risk of losing your home has increased as you have reduced the amount of equity available, should you become unemployed or need to tap into it for an emergency. Using the improved cash flow wisely can make all the difference in succeeding with your financial goals.  However, this strategy can be a very bad move if you are not disciplined.  You run the risk of running up your personal debt all over again once your credit cards are paid off and freed up.  That is not the way to achieve a financial goal of being debt free.

You should have a payment on the new mortgage that is higher than the previous one and you have to be able to pay it on time every month.  Your new mortgage consolidation loan payment will be less than the previous total debt payment you had, freeing up cash you need to be very careful with so you don’t waste the opportunity you have to get ahead.

Remember, you’re working towards becoming totally debt free so you can enjoy a comfortable retirement.  With the right strategy you could achieve that and more.