With interest rates still on the rise, an increasing number of homeowners are looking at making use of the equity they have in their homes to “consolidate” all their debts and pay off everything except their home loan.
The reason for this is that home loans typically attract much lower rates of interest than any other kind of debt.
However, debt consolidation plans should come with big warnings that only very disciplined borrowers should make use of them.
Making a decision to do this means that you will essentially be using your home as security to enable you to pay off your car, credit card, personal loan and whatever other debts you may have – and that you will need to set strict repayment goals so that you don’t risk losing the property.
There are two ways to use home equity for debt consolidation, as follows:
- If the capital component of your home loan has been reduced over time and is now well below the value of your home, you should be able to re-access a portion of the original loan and use this to pay off your higher-interest rate debts; or
- If the value of your home has increased substantially since you bought it, you may be able to “refinance” – which means taking out a new, bigger home loan and using the difference between this and what you currently owe on your home to pay off other debts.
Either way, though, your aim should be to pay off the additional amount that you borrow as fast as possible and get your home loan liability back to where it was before the debt consolidation.
You need to be very clear that borrowing the extra amount and then extending the repayment period of your home loan to make the instalments more affordable does not represent a real saving – and could actually cost you more interest in the long-term than you might have paid on the original debts.
Your best move is to divert as much as possible of the money you were using to pay off your other debts and add it to your new home loan repayments. This will really help to reduce the new loan as fast as possible, and lower the monthly repayment to make that more affordable in the face of rising interest rates.
In addition, it is extremely important not to take on any new debt until the additional amount you have added to your bond is paid off. This may mean you have to change your spending habits and be very strict about cutting back on any non-essentials, but it is the only way to achieve the real objective of debt consolidation, which is to be as debt-free as possible.
Finally, you should be prepared to negotiate the interest rate on a home loan refinance just as much as you did on your original loan, preferably with the assistance of a reputable mortgage originator, and be prepared to pay the registration costs for any new loan upfront, so that you avoid the interest charges on those costs over the life of the loan.
Berry Everitt is CEO of the Chas Everitt International property group.