Consolidating Mortgage – Advantages and Drawbacks
Your mortgage is most likely the largest debt you have in your budget, however, it can also be one of the most useful. In most cases a home loan is good debt because it has a relatively low interest rate, is secured by an appreciating asset and has a fixed repayment term, so you know exactly when you will be debt free.
With an appreciating asset such as your home, while you are paying your loan down, the value of your house is going up. This accumulates equity as equity is the difference between the value of your home, and what you owe on your loan. For example, if your remaining home loan balance is $250,000 but your home is valued at $350,000 you have $100,000 worth of equity, which can be just like having money in the bank.
However, when you refinance your mortgage to access this equity, you need to make sure the advantages apply to your situation, and that they outweigh the dangers and drawbacks.
The benefits of refinancing your mortgage include :
- Saving interest on bad debts. When you refinance your mortgage you can consolidate other debts into your home loan. This means you use the equity in your home to pay off credit cards or personal loans, and you pay off one loan at a low interest rate. While the interest on your home loan may seem significant, the interest rate is actually much lower than personal loans and credit cards.
- One monthly repayment. With all of your debts consolidated into your mortgage, you have just one monthly repayment to make, rather than having to remember each card payment. This means you can also avoid late fees and bank payment charges.
- Fewer debts on your credit report.When you consolidate your mortgage with your other debts, it appears that you have fewer debts on your credit report. Instead of two credit cards, a personal loan and a mortgage, you now have just one mortgage to repay.
- Access equity to increase the value of your home. You can refinance your mortgage to access the equity in your home for renovations or improvements. When the renovations you make increase the value of your home, the value of your equity also goes back up.
- Little risk of negative equity. In most cases you will only be allowed to borrow up to 80% of the equity which is available in your home, so there is little risk that your loan will be more than the value of your home. For example, if you have $100,000 of equity available, you will be able to refinance to borrow just $80,000 of that amount.
At the same time, keep in mind that there can be drawbacks to refinancing to consolidate your mortgage, and these include :
- An increased loan amount. When you draw down on the equity in your home you are increasing your loan amount, and in turn your home loan repayments. Therefore, you need to be sure you can either afford to make the higher repayments, or you have the time to extend the loan term to reduce your repayments over time.
- An increased interest amount. With a higher loan amount you are also paying more interest over the life of your loan. This means your home loan becomes more expensive, and if you are consolidating your mortgage with other debts, you would have paid less interest on your debts individually, than what you are paying on them over the life of your loan.
- Higher loan to value ratio. When you have a high loan to value ratio you have borrowed an amount closer to the actual value of your home. This means that if you needed to sell quickly for example, you may make a loss on the property, because you can’t wait for a price which pays out the remainder of the loan, and leaves some funds spare.
- Lenders Mortgage Insurance. When you have a higher loan to value ratio, your loan is considered riskier and you may need to pay lenders mortgage insurance. This is an added cost which you may need to pay up front at the time of refinancing, or as an ongoing charge over the life of the loan.
- Overcapitalisation. If you borrow to renovate or improve your home, you need to be careful you don’t overcapitalise on the property. If you spend $50,000 on renovations for example, you may not add $50,000 to the value of your home, because of the area it is in, or other features of the property.
- Fees and exit costs To refinance your home you need to complete a new home loan application. Even when you are refinancing with the same lender there can be application fees and exit fees payable if you need to add to or change your loan product. In some cases these costs can be tens of thousands of dollars, so make sure that the benefits of refinancing to consolidate your mortgage, outweigh the costs.
