Holiday Debt Overwhelming?
Consolidate Debt: With Equity of Your Home
Holidays are now concluded, the excitement and joy and hopefully the bloating has now subsided. As regular schedules have returned, back to normal work life balance, One thing might be weighing on you as it usually does this time of year holiday spending and the debt that comes with it! This might have pushed you over your borrowing limit, Maybe some unforeseen expenses came up over the holidays, in addition to the time of year your DEBT is just too much, as you are having a difficult time catching up. Lucky for you Home Owners out there, you have access to many great solutions to help consolidate your debt to help you manage and lower your monthly payments.
What is Debt Consolidation:
Let’s start with what Consolidating debt is. Many times when the term Debt Consolidation is brought up, it can be thought of ‘eliminating debt’. This is far from the truth. Debt consolidation is a debt management strategy. It combines multiple debts into a single loan. You still have the same debt. Its goal is to:
- Reduce monthly payment
- Increase cash flow
- Pay less interest
- Avoid late payments
- Pay off debt faster
- Easier to manage
Let’s look at an example:
Debt You Are Carrying:
- $20,000 in credit card debt @ 20% rate – $350 minimum monthly payments
- $20,000 Trailer or boat or RV Personal or Instalment loan @ 10% rate – 500 Monthly payments
- $10,000 used car @ 10% financing – $500 monthly payment
- Total Monthly Payments = $1,350 Month
You are looking to consolidate this debt using your home’s equity. Most cases a refinance is the vessel used to access your homes equity to consolidate your debt
Current Monthly Payment:
- Your home values it $700,000
- Mortgage is $450,000
- Mortgage rate is 2%
- Monthly mortgage payments are $1,905.53
- You need $50,000 to cover debt
New Monthly Payment:
- You refinance $500,000
- New Interest rate is 5%
- 25 Year Amortization
- New Mortgage payment is $2,908.02
New Monthly Payment:
- Old Mortgage ($1,905.53) + Old Debt ($1350) = 3,255.53
- New Mortgage =2,908.02
- Cash flow =$353.51 / month
As mentioned before, you still have the same debt. What happened is we moved multiple higher interest debt to one lower interest rate debt, that being YOUR MORTGAGE. This additional $350 is usually recommended to place against your mortgage to gain more equity and pay this debt off faster!
A refinance is usually the option most will take to consolidate debt. It does bring some down side in some situations. So let’s dive into what a refinance is.
What is a Refinance:
A Refinance is a makeover of your existing mortgage. You are negotiating a new mortgage that will replace your current mortgage where the amount of the mortgage, term, Interest rate, amortization and lender could all change.
When you are refinancing you are only able to pull 80% equity (or LTV) of your home in most cases.
- If your home value was $600,000 you could only draw $480,000.
You could not cover all your debts and would leave $20,000 high interest debt remaining from the example above.
A refinance can be done during any of your mortgage, not without risk. With any refinance you will be looking at closing costs and even penalties. Anytime you change your primary mortgage before the end of term for example; purchasing a new home, or refinance. There will be closing and penalty costs associated. These penalties are affected by; how far along the term you are, the rate you have, and the size of the mortgage. (More On This In Another Post)
For an example for consolidating debt, we are going to use the previous case. In this example the NEW interest rate was higher, at 5% (same example as previously shown).
Debt You Are Carrying:
- $20,000 in credit card debt @ 20% rate – $350 minimum monthly payments
- $20,000Trailer or boat or RV Personal or Instalment loan @ 10% rate – 500 Monthly payments
- $10,000 used car @ 10% financing – $500 monthly payment
- Total Monthly Payments = $1,350 Month
Current Monthly Payment:
- Your home values it $700,000
- Mortgage is $450,000
- Mortgage rate is 2%
- 25 Year Amortization
- Monthly mortgage payments are $1,905.53
- You need $50,000 to cover debt
New Monthly Payment:
- You refinance $500,000
- New Interest rate is 5%
- 25 Year Amortization
- New Mortgage payment is $2,908.02
Cash Flow:
- Old Mortgage ($1,905.53) + Old Debt ($1350) = 3,255.53
- New Mortgage =2,908.02
- Cash flow =$353.51 / month
Here’s an example for consolidating debt; we are going to use the previous case. In this example the NEW interest rate was higher, at 6%.
Current Monthly Payment:
- Your home values it $700,000
- Mortgage is $450,000
- Mortgage Fixed rate is 2%
- 25 Year Amortization
- Monthly mortgage payments are $1,905.53
- You need $50,000 to cover debt
New Monthly Payment:
- You refinance $500,000
- New Interest Fixed rate is 6%
- New Mortgage payment is $3,520.08
Cash Flow:
- Old Mortgage ($1,905.53) + Old Debt ($1350) = 3,255.53
- New Mortgage =$3,520.08
- Cash flow = -$264.55
You would now be paying more monthly, a refinance would not be the option we would want to take. Not only are the monthly payments higher, Not to mention the penalties that would be associated with a refinance.
PLEASE NOTE: A refinance in this case where the interest rate has risen from our current interest rate may not be the route we would take to consolidate debt. Like we explained before, this example does not include CLOSING COST or PENALTIES that would likely be associated with this. In a case of a refinance we would want our new rate to be very close or lower than our current rate. We might look at a Home Equity Loan or a Home Equity Line Of Credit ( HELOC )
| Pros of a refinance for consolidating debt | Con’s Refinance for consolidating debt |
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*There is plenty more information on refinancing, their abilities, pros and cons. In this post we are only looking at a refinance and its abilities to consolidate debts. We will be covering refinancing more in depth in another post. If you have any questions please reach out. *
Home Equity Loan:
A Home Equity Loan is a second charge or second mortgage on your home. This means that you keep your current mortgage. The amount, term, interest rate, amortization and lender all stay the same. Think of it like a sidekick to your primary mortgage. With a Home Equity Loan, you will receive the whole amount up front as a lump sum. They are a fixed rate with usually a 5 year amortization period. You will be paying principal and interest in your monthly instalments like your primary mortgage. With this type of loan similar to a refinance, you are putting the amount borrowed against your home’s value (Equity). In most cases you are able to use up to 80% (or LTV) of your home’s value like a refinance.
Home Equity Loan can have big upside when consolidating debt. For one, if you do not want to break your current mortgage because of the low rate (2%). With this Loan, you keep your favourable 2% rate on your primary mortgage. You have not broken your primary mortgage therefore there is no penalty but there will be closing costs. Estimate up to 2% of your loaned amount to come off the top. For this scenario about $1,000 will come off the top leaving you $49,000 of equity. Other potential down sides of this type of loan are. As this mortgage type is placed in second position it is a high risk for lenders. Many lenders may not want to lend money to applicants that may have poor credit. Placed in second position the rate will almost always be higher than primary mortgage or a refinanced mortgage. You can not reuse money you have paid back against the loan.
Lets use our previous example:
Debt You Are Carrying:
- $20,000 in credit card debt @ 20% rate – $350 minimum monthly payments
- $20,000Trailer or boat or RV Personal or Instalment loan @ 10% rate – 500 Monthly payments
- $10,000 used car @ 10% financing – $500 monthly payment
- Total Monthly Payments = $1,350 Month
Primary Mortgage + Home Equity Loan:
- Your home values it $700,000
- Mortgage is $450,000
- Current mortgage Fixed rate is 2%
- 25 year Amortization
- Monthly mortgage payments are $1,905.53
Second Mortgage (Home Equity Loan):
- You need $50,000 to cover debt
- You take out a Home Equity Loan (Second Mortgage) of $50,000
- Rate on this NEW Fixed rate loan is 7%
- 5 Year Amortization
- Home Equity Loan Monthly Payment = $987.70
Cash Flow:
- Primary Mortgage + Debts = #1,350 + $1,905.53= $3,255.53
- Both Monthly mortgage payments = $2,893.23
- New Monthly cash flow of = $362.30
| Pros of Home Equity Loan for Consolidating Debt | Cons of Home Equity Loan for Consolidating Debt |
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*There is plenty more information on refinancing, their abilities, pros and cons. In this post we are only looking at a refinance and its abilities to consolidate debts. We will be covering refinancing more in depth in another post. If you have any questions please reach out. *
Home Equity Line of Credit (HELOC)
Like a Home Equity Loan, a HELOC will fall into the category of a second mortgage as it is charged against the home using the equity. A HELOC will also have closing costs, but this also means your Primary mortgages stay intact. This could be a big benefit if you have a favourable mortgage rate and term that you do not want to break when consolidating debt.
Unlike an Home Equity Loan, you are only able to access up to 65% of your home’s equity (or LTV.). So for a $700,000 valued home, the most you can access with a HELOC is $455,000. You do not get a lump sum like a Home Equity Loan. Similar to a credit card, this is a revolving debt. Where you draw money when you need money and repay when you have cash flow. This type of loan is an interest only during the borrowing period, typically 5-10 years. You may pay down the principal or balance ( money that has been borrowed against this line of credit) at any time. Doing so will give you access to the funds that you have been paying down. Now if you are one that is responsible and can stay on top of this type of revolving debt. This type of loan is great. If you are not careful, at the end of the draw period if you have emptied the boring limit, you could have some issues.
At the end of your draw period you have the ‘Payback Period’. In this period you are now charged principle and interest of the drawn out. If you are not careful and get too comfortable with the interest only payments during the draw period and have maxed out borrowing against this line of credit. You may be in for a difficult time. Not only do you have to be careful with your funds borrowed. A HELOC is a variable rate, in that it moves with prime. If Prime goes up, so does the rate on your borrowed amount. You could charge different rates on what you have borrowed. THis is usually prime +.50% – 1.00%. This will depend on how much borrowed, term, credit score and more.
So for example:
Debt You Are Caring:
- $20,000 in credit card debt @ 20% rate – $350 minimum monthly payments
- $20,000Trailer or boat or RV Personal or Instalment loan @ 10% rate – 500 Monthly payments
- $10,000 used car @ 10% financing – $500 monthly payment
- Total Monthly Payments = $1,350 Month
Primary Mortgage + Home Equity Loan
- Your home values it $700,000
- Mortgage is $450,000
- Current mortgage Fixed rate is 2%
- 25 year Amortization
- Monthly mortgage payments are $1,905.53
Second Mortgage (HELOC)
- You need $50,000 to cover debt
- You take out a the entire amount of the loan of $50,000
- Rate on this NEW Fixed rate loan is ( Prime + 1.00%= 6%)
- 5 Year bowrring period
- HELOC * Interest only = $250
Cash Flow
- Primary Mortgage + Debts = #1,350 + $1,905.53= $3,255.53
- Both Primary mortgage and HELOC = $1,905.53 + 250 = $2,155.53
- New Monthly cash flow of = $1,100
Now be careful as yes you have now gained a great amount of monthly cash flow, you have not been charged principle. We recommend you use this extra cash flow to pay down your principal. Because a huge upside of leveraging this way is that you immediately gain access to principle you pay down.
| Pros of Home Equity Line of Credit (HELOC) for Consolidating Debt | Cons of Home Equity Line of Credit (HELOC) for Consolidating Debt |
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