Did you know that if you have any debt other than a mortgage debt it is very likely at a higher interest rate than secured mortgage borrowing? In fact, even if you have lots of extra cash flow and pristine credit you may lower your payment and interest cost by rolling this into your current home equity. With mortgage rates near a record low and showing no signs of heading up anytime soon, there’s never been a better to consider refinancing your mortgage. With today’s rates – home equity debt consolidation loans are a great way to save money and potentially grow your wealth (where the math make sense).
The Benefit
Many homeowners find themselves house rich, cash poor, especially in pricey real estate markets like Toronto and Vancouver. If your monthly cash flow is tight or you want to lower your costs, you may be able to refinance your mortgage and use the proceeds to pay off your bills. The major reason to consider refinancing is to lower your total monthly payments. With refinancing you get the best of both worlds: you get your debt under control and get to keep your home – it’s a win-win situation for homeowners.
Here’s how debt consolidation works: all your existing debt is rolled into a single loan at a significantly lower interest rate. Paying 2.7 % is a lot better than paying 5% on unsecured credit lines or having credit cards at 18% or higher! When consolidating debt, a new mortgage is taken out to pay off your existing debt. You’re able to start with a clean slate and get your debt situation under control.
The Cost
While debt consolidation sounds great on paper, there’s one major hurdle in the way of everyone taking advantage: mortgage penalties. If you have a closed mortgage like most, you have to pay a hefty penalty to break your mortgage. We’ve written about many times how the big banks are unscrupulous when it comes to mortgage penalties (or click on http://www.calumross.com/blog/bank-rates/big-bank-mortgage-penalty/).
Calculating mortgage penalties can be tricky. That’s why it’s important to sit down with a mortgage specialist and do the math to see if breaking your mortgage makes sense. If you have a variable rate mortgage, it’s pretty easy to figure it out: three months’ interest. However, if you have a five-year fixed rate mortgage likes most Canadians, that’s where it gets more tricky (and costly).
With a fixed rate mortgage, you’ll pay the greater of three months’ interest or the Interest Rate Differential (IRD). The IRD has become a curse word among many homeowners. It results in homeowners shelling out thousands in mortgage penalties to their bank (the penalties can sometimes be more than a new car!). Make sure you find out what you mortgage penalty will be before consolidating debt. If you’re with one of the big banks it can be quite hefty. If you’re with a secondary lender, it might be more reasonable.
On another note – if you are breaking the mortgage to earn income (aka borrowing to invest) with some of the funds then by creating the right mortgage paper trail you can make your mortgage penalty tax deductible. Making this tax deductible can decrease your cost of the penalty by over 45% for higher income earners. This makes the savings a lot more compelling!
The Bottom Line
Before you break your mortgage to consolidate debt, you should have a qualified mortgage professional who has a financial planning background review your situation and make a recommendation. By doing the math, you can make sure refinancing your mortgage makes sense. If you’re hit with a big mortgage penalty, you can often maximize your prepayment privileges to lessen the penalty (the big banks won’t tell you that). Try out our handy debt consolidation calculator to see if debt consolidation makes sense.