Should you consolidate your debts into your mortgage?

by Tom Tousignant

in Blog, Mortgages, Refinancing

If you find yourself in a situation where you have equity available in your house, and also have a bunch of other debts, such as credit cards or auto loans, you may consider refinancing and rolling the debts into the new mortgage.

Most people will tell you not to do a consolidation loan, but, like so many other things, “It Depends”. 

There is a right way and a wrong way to roll your credit cards or auto loans into your mortgage.  First, the wrong way – if you simply get a larger mortgage and spread out your payments on your 3 year old car for 30 years, you are probably making a mistake.  More importantly, why do you have the other debts?  Are they from a specific event or cause, such as a medical emergency, or are they a result of a lifestyle that consistently out-spent your income? If your accumulated debts are just a habit, then rolling all the debts into a new mortgage will likely leave you with a bigger mortgage and more credit card debt just 2-3 years later.  You will be worse off than if you never refinanced.  However, if you can point to a specific cause of the debts, and can show a track record of reducing those debts over the last 6-12 months, then you may be able to refinance and benefit from lower, tax-deductible interest payments rather than high interest rate credit cards.

The Right way to consolidate your debts into your mortgage:

First, know the reason the debts are there – if you can’t tell why you have the debts, then paying them off will not stop them from re-appearing.  In fact, you will go back into debt if you are in the habit of using credit cards to get by.

Second – know what your amortization schedule looks like.  From an amortization schedule you can see how long it will take for the added debts to be paid off.  The Amortization schedule will vary based on the term of the loan and the interest rate.  As an example, take a look at the table below.  This is for a $200,000 mortgage. 

Loan Term

30 Years

30 Years 5%

20 Years

15 Years

 

 

 

 

 

Payment

$1,199

$1,073

$1,319

$1,581

Years to re-pay $25,000 Equity

8 Years

7 Years

3.8 Years

2.5 Years

You can’t control the interest rate – the market sets that, but you can control the term.  The real difference is with shorter loan terms – using a 20 year term pays off the $25,000 addition in just 3.8 years and a 15 year mortgage pays off $25,000 in only 2.5 years!

Third – Accountability.  If you are going to pay off debts and more importantly, stay out of debt, an accountability system is critical.  Usually this would be a financial planner or advisor that regularly reviews your finances with you.  Accountability can also come from an annual mortgage checkup with a mortgage planner.  When we review a client’s mortgage, we look at the credit report changes over the past year, the performance of the mortgage and the value of the house.  If debts are creeping back in, immediate changes need to be made to keep the plan on track.

Debt Consolidation Mortgage Power Play:

The absolute best way to consolidate debts into a mortgage is to use the shortest mortgage term possible.  By eliminating credit card payments or auto loan payments, the shorter term and higher payment of a 15 or 20 year mortgage suddenly becomes affordable.

In this example below, a client used a 15 year mortgage to pay off $28,000 in credit cards and car loans.  By eliminating the credit card and car loan payments, the borrower was able to use a 15 year mortgage and rapidly build equity in their house.

 

Current Mortgage and Debts

Proposed Plan(15 Year Mortgage)

Mortgage Payment

$1,330

$2099

Auto Loan Payment

$462

$0

Credit Card Payments

$324

$0

Total

$2,116

$2099

Total Debts Paid Off

$28,000

n/a

Equity after 5 Years

 

$64000

Years until Debt Free

25

15

 Even is this borrower needed to finance a new car in a few years, the added equity in their house would exceed the new auto loan liability.  The usual outcome, however, is that once the habit if credit cards and auto loans is broken, a person finds it easier to save, so they are able to pay cash for future cars.

 So, before you listen to the pundits that tell you to never roll your debts into a mortgage, consider the effect of the amortization schedule, the loan term, and the reason the debts exist and make the best decision for yourself. 

This is another example of why I tell people to “Start with the House” to reach financial freedom.  If you have  a sound plan for consolidating debts into a new mortgage, you can build wealth and find yourself debt free faster.

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