Often, people who need debt consolidation advice will shy away from refinancing a mortgage in order to pay out large amounts of consumer debt. These debtors will normally be entering their mid-life stage, or just coming out, and will have taken an aggressive repayment plan with their mortgage, resulting in a much-shorter amortization. They will be mortgage-free sooner. Great work!
The reality, however, is that even with a reduced amortization while carrying tremendous amounts of consumer debt does not make any sense whatsoever. Refinancing a mortgage and taking advantage of the unused equity in your home to repay consumer debt makes the most sense and we highlight three of the most obvious reasons here.
First off, interest rates on consumer debt are normally way higher than rates people pay on mortgages. This is because real estate is still considered the best form of consumer collateral. Refinancing a mortgage to pay out consumder debt means lower interest costs over the course of the repayment period. Since people owe this debt regardless of whether it is secured by a mortgage or unsecured, the only difference is that consumer debt gets paid with the mortgage and not with mailed credit card or loan statements. What will you do with the interest savings?
The second is that consumer debt typically comes with a higher monthly payment amount compared with mortgages. The reason is simple; mortgages can be amortized over longer periods (typically decades) where consumer debt is normally repaid over shorter periods (rarely even close to a decade). For cash flow reasons, it makes sense to refinance a mortgage. To illustrate, consider a $50,000 loan repaid over 72 months at a rate of 8.9% versus a mortgage of the same amount repaid over 25 years at 5.75%. The difference in cash flow is $586.24 if this debt were finances as a mortgage. What would you do with this much extra cash every month?
Three is for simplicity. The average North American carries balances on thirteen different credit cards. This suggests that this average person is making thirteen different payments on a monthly basis plus a regular mortgage payment. By refinancing a mortgage, those thirteen different payments will get replaced by the lone mortgage payment. How will you spend that extra time?
Of course, nobody who looks at refinancing a mortgage plans on carrying that debt until the end of time. The goal is always to be mortgage-free, but when people carry consumer debt at the cost of paying off that mortgage, they are actually taking steps backward. All you have to do is consider the higher costs and payments associated with consumer debt. A common objective might be that securing consumer debt with your home puts your house at risk. Well, if you can’t make your mortgage payment, the mortgage company will foreclose, regardless of whether you owe money to someone else. With that in mind, would it not make more sense to use your equity so that you increase cash flow and reduce the risk of default on the mortgage?
