Consolidating Unsecured Debt & Your Mortgage
Did you know that, among Canadians, the average household debt ratio is at a steady climb and currently sits at 176.9%; as per Statistics Canada. That ratio measures the proportion of debt to disposable income. The average Canadian owes $1.77 in credit for every dollar of disposable income (after taxes).
Among Canadians that have debt other than mortgages, the average balance due is over $15,000 – much of that due on credit cards. The interest alone on that can cost as much, per month, as another car payment. So debt consolidation is a topic that has become popular among Canadians.
If you have built up a considerable amount of consumer debt while also building equity in your home, you may be tempted to refinance your mortgage and roll that debt into your mortgage, because home loans generally charge lower interest than credit cards. This works for a lot of people – but it doesn’t work for everyone. This article will walk you through the process, along with pros and cons.
How does consolidating debt into a mortgage work?
As you pay off your mortgage, you build equity in your home. The difference between the current value of your home and what you still owe on the mortgage balance is the equity. If property values have increased since the time you purchased your house, then your equity increases even more.
So as you build equity, you may run into other expenses that are significant, such as college tuition, vacations, or unexpected medical bills. You can also run into some financial troubles, such as job loss that force you or your partner to stop working for a time. The equity in your home can look fairly attractive as you start to build debt on your credit cards.
If you go through this, your mortgage balance will go up by the credit card debt you roll into it, in addition to the closing fee and/or prepayment fees for breaking your mortgage, which can easily run to several thousand dollars. Even in doing this, your interest rate should be significantly lower, and your cash flow can increase.
Should you consolidate your consumer debt into your mortgage?
There is not a simple answer for everyone. Each person’s situation is different. The rules for mortgage qualification are much more stringent than they once were. There could be a penalty for breaking the mortgage that you are currently in, depending on your lender’s guidelines. There are some other questions, of course. What would the new interest rate be? Would that rate end up saving you money?
Is there any reason not to consolidate consumer debt into mortgage?
In many cases, when property owners consolidate the debt into their mortgage, they extend the term of mortgage; which in turn lengthens the debt repayment period and interest on your property. You could also end up using equity now, eliminating access to it for potentially more urgent matters. Also, if the housing market softens, and you are close to renewal, you might have a hard time extending and refinancing your mortgage if you’ve tapped too far into your equity. If you find that you keep putting more expenses on your credit cards, it is suggested to put together a budget that will allow you to make your new mortgage payment in the confines of your existing financial situation.
If the lender allows, do not close your accounts after you pay those cards off, if you do consolidate. That will decrease the average age of your credit accounts, which might lower your score. Just put the cards away – cut them up if you need to.
What alternatives are there to help me pay off my consumer debt at a lower interest rate?
A home equity line of credit (HELOC) is slightly different from a 2nd Position equity mortgage loan; but still considered a mortgage. A HELOC provides you an amount for you to use as you need to. If you don’t access the line of credit, you don’t pay on it, but it is there if you need it. One potential downside is that interest rates are variable, so they could increase. In today’s current economy, rates are expected to stay low for a very long time. Even with a HEOC, you have the same risk of running through your equity if you’re not financially disciplined.
A debt consolidation loan is another way for you to lower your interest rate without putting your home equity at risk. Some financial institutions offer a debt consolidation loan that will pay off your consumer debt, and then leave you with a lower interest rate. However, you want to do this while your credit is still very good, so that you get an interest rate that is low enough to benefit you. You also want to follow the same advice given above – putting together a budget that will keep you from adding to your consumer debt now that you have the consolidation payment.
A balance transfer credit card can make sense if you get a good deal. Some cards offer an introductory period of six months, or even longer, with a zero percent interest rate on balance transfers, or a low introductory rate. You do have to provide income verification and have solid credit scores to qualify for most of these cards – and the rate can go up as high as your current cards after the transition period. But if you can get a deal and pay the balance off during the introductory period, that can make a big difference in interest expense.
You can also withdraw from your retirement account. If you take money out of an RRSP account, you would face a withholding tax. If you take out more than $15,000, 30 percent gets withheld – and you would owe income tax on the amount you took out. So this would be an emergency withdrawal, given the overall costs involved.
Another source of credit would be a loan against other property. Perhaps you have a clear title on a car, or your investment accounts have reached a certain value. Maybe you have some pieces of fine art or some valuable jewelry or other collectibles. You can take out loans against those if your credit is not where it needs to be for some of these other solutions. However, those interest rates can be very high, and you could lose the items you put up for security if you miss a payment.
One additional option is a reverse mortgage, available if you are a Canadian homeowner who is at least 55 years of age. The loan amount is based on your home equity, the home’s location and the borrower’s age, so credit score and income are not as important. You don’t have to make any payments unless you sell the house or move out, and you are guaranteed not to run out of equity as long as you stay in the house. Interest rates are higher than traditional mortgages, but lower than most credit card rates.
If none of the above are possible, but you really need a short term solution to consolidate; the following options are available.
- Informal Debt Settlement – You negotiate your unsecured debts with your creditors to pay a reduced lump sum to eliminate your debts. This is usually done using a debt settlement company, but can also be done by yourself if you have some savings but just not enough to clear all the debt.
- Bankruptcy or Consumer Proposal – Very Similar to Debt Settlement; however you’d need to work with a Trustee to determine which method is right for you.
- Private Equity Mortgage – Similar to a HELOC, but are commonly interest only and more expensive than the banks. This is commonly used when a traditional mortgage isn’t an option and a property owner doesn’t want to file for Bankruptcy or Consumer Proposal. In some cases, this type of mortgage is used to payout Consumer Proposal so that a Property Owner can fast track the credit rebuilding process.
If you have questions about your current situation, give one of our debt consolidation experts a call today or apply through our website. We don’t check your credit for an initial assessment. It only takes a minute. We generally respond the same day, or within 24 hours if completed after hours.
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