Consolidating Debt Into Your Mortgage
In July’s webinar we looked at consolidating debt into your mortgage. You might be wondering what exactly debt consolidation is? Heard about a home equity line of credit? We covered all that and more. So, let’s dive in.
Debt consolidation is the process of financing two or more debts into one. There are many reasons why people consolidate their debts – some examples are to reduce their payments, or to consolidate all payments into one payment.
Since ‘Debt Consolidation’ can mean different things to different people, it is very important that we clearly define what it means. In this article, debt consolidation means that you pay off your debts by yourself – either from your own resources or through your mortgage – and not through a third-party company that will put you in an official debt consolidation program such as credit counselling, consumer proposal, debt settlement, bankruptcy, etc. If at all possible, credit counselling, consumer proposal, debt settlement and/or bankruptcy programs should be avoided since they can impact your credit for many years to come.
Let’s look at the whole picture
Before you decide to refinance your debt into your mortgage, understand why you created the debt in the first place. This is really important to know so that you can avoid making debt again. Remember, consolidating your debt only deals with the symptoms of a greater problem. Without knowing the root cause of your debts, you may repeat the same mistake again and again.
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The best way to avoid major ups and downs in your budget is to rely on your reserve funds. Save and maintain a rainy-day fund to avoid you getting into debt when you have a deficit in your budget.
One of the greatest fears and dangers for people who consolidated their debts is that they will get back into debt. This is a very real concern and you should do everything to avoid repeating your past mistakes. You should probably close some credit cards and lines of credit to prevent you from have easy access to credit in the future. However, we don’t recommend that you cancel all of your credit cards/lines of credit because your credit will collapse if you do, and you may find it hard to get a good mortgage in the future.
Unlike a personal line of credit, a Home Equity Line of Credit (HELOC) is secured against your home, just like a mortgage, except you normally only have to pay the interest on the HELOC every month. The question is, “Should you ask for a HELOC with your mortgage or not?”
Here are a few points that you should seriously consider before you apply for a HELOC:
- HELOCs are a major reason why people don’t pay their homes off
The low interest rates and easy access to money cause people to utilize their HELOCs for various and often wrong reasons. For example, for the same loan amount of $100,000 a car payment may be $1,841/m [3.99% | 60 months] vs a HELOC payment of $254.17/m [3.05% | Interest Only]. This can give the illusion of affordability, but the loan amount is the same in either case and utilizes the equity in the home for probably the wrong reason.
- Less mortgage choices
Not every lender offers HELOCs, so you will have limited lender choices.
- HELOCs – variable rates
The interest rates on HELOCs are usually variable and will change whenever the lender changes its prime lending rate.
- Demand loan
Most HELOCs allow the lender to call the loan at any time. This means the lender can require the borrower to pay back the HELOC balance within a short period of time.
- Higher interest rates
Not only are HELOCs themselves at higher interest rates than normal mortgages, but they also cause your mortgage to be uninsurable and that will also cause your mortgage to be subjected to higher interest rates.
- Reduced freedom of movement
Once you have a HELOC with a lender you have less freedom to move to different lenders that may offer better mortgage products. HELOC products can be very complex and lenders secure other products such as credit cards, against your home. This may seem convenient at first, but makes it more difficult for you to move your mortgage to a different lender.
As you can see from the above; unless you have a very specific need for a HELOC, you should be very cautious about HELOCs.