Debt Consolidation

Debt, by nature, has a tendency to run away. For those of us with multiple debts owed to multiple lenders, this is even more true. Unchecked, debt can easily take over your finances and your life. Before you know it, you owe more than your assets are worth and your monthly paycheck gets eaten up by interest payments, leaving you little leftover to pay down principle. It’s a vicious cycle that digs you deeper and deeper into debt.

Debt consolidation can help you break the cycle.

Unlike bankruptcy, which leaves your credit in tatters and your assets picked clean, debt consolidation is like a bailout in which you come to your own rescue. Rather than having your debts written off or forgiven, you are simply using your own resources and assets to structure your multiple liabilities into a more manageable repayment scheme. Incidentally, you often wind up paying much less in interest. For these reasons, debt consolidation can easily be a win-win situation for both you and your creditors - you pay less overall and they get what’s owed to them.

How Debt Consolidation Works

Debt consolidation works by paying off all your creditors in full and then rolling the costs into a single loan, often with a lower overall interest rate. In most cases, a lender will either give you the cash to pay off your creditors or pay them off themselves. At this time, your relationship with your other creditors ends and you stop accumulating interest.

For example, let’s say you have three credit cards, each with a balance of $15,000 and an interest rate of 23.99 percent. Meanwhile, you have an auto loan with $20,000 left and an interest rate of 12.25 percent. You also have $50,000 in student loans at 10.00 percent and $7,000 in unpaid medical bills that accrues interest at 15.75 percent. To consolidate these debts, you could take out a loan for $122,000 at an interest rate of 9.25 percent. You would eliminate your high interest debt and begin paying the lender who gave you the consolidation loan a single monthly payment at your lower rate.

In the above example, you may also pay less in monthly payments as well. Each of those six accounts required its own minimum monthly payment, and if you did not have enough to cover each one, you would have to choose which one to be late or delinquent on. With consolidated debt, you don’t have to make this choice and you don’t have to accrue penalties.

Debt Consolidation and Your Home

So, why are debt consolidation loans so much more affordable than the various other high interest debts? Consolidation loans often have lower interest rates because, unlike a credit card or student loans, they are secured with collateral. One of the best sources of collateral is the very home you live in.

By securing your loan against your property, you can get lower interest rates on all of your debts without drastically changing your lifestyle. As long as you do not default, you can still live in your home. There are a number of ways to use the value of your home for debt consolidation:

Home Equity Loans: Home equity loans let you use your home equity as collateral. For example, if you own $100,000 on your mortgage, but your home is worth $150,000, you can borrow up to $50,000 via a home equity loan. You’ll receive $50,000 as a lump sum and repay it in monthly installments or as a line of credit. You can use this cash for whatever reason you see fit, including debt consolidation.
Second Mortgages: Similar to a home equity loan, second mortgages allow you to take out an additional loan against the equity in your home. These can be fixed or variable mortgages that place a second lien on your home in addition to your original mortgage.
Remortgage: A remortgage, also known as mortgage refinancing, is when you negotiate a brand new mortgage that replaces your original mortgage. For example, if you owe $50,000 on your home, you can get a new mortgage for $100,000 and use half of it to pay for your old mortgage and use the rest for debt consolidation.
Reverse Mortgage: For homeowners over 62 years of age, a reverse mortgage allows them to cash out the equity in their home and defer repayment until they move or pass away. The cash can be used for debt consolidation or to pay other expenses.

Home Mortgage and Debt Consolidations

The inherent benefits of using your home as collateral for debt consolidation are the low interest rates you’ll get, especially when compared to unsecured loans. Furthermore, depending on your situation, the interest you pay on your home equity loan or second mortgage may be tax deductible.

However, as with all debt instruments, home mortgage debt consolidation carries risks. Namely, if you default on a home equity loan or refinanced mortgage, you could lose your home.

We recommend comparing your options, researching mortgage brokers and subscribing to our mortgage blog so you can make an informed and educated decision. Check out some of our relevant blog topics below for further reading:

What type of loan provides low interest debt consolidation?