Is consolidating debt into your mortgage a good idea?

By Mark Rosanes

Paying off multiple debts at once can be very stressful – and if these debts are not managed properly, they can end up costing you more and dragging you further into debt. If you find yourself having difficulty juggling your debts, consolidating them into a single loan may be helpful in managing your repayments.

One of the ways to do this is through refinancing. Consolidating other debts – usually a car or business loan, or a large credit card bill – into a mortgage is among the most common reasons why many Australians refinance their home loans. However, this strategy does not work for everyone. Before opting to take this route, you need to carefully weigh the pros and cons to see if it suits your financial situation.  

How does a debt consolidation home loan work?

By refinancing your home loan, you can bundle some or all your existing debts into your mortgage. The aim is to make it easier for you to pay off these debts through a weekly, fortnightly, or monthly basis at a lower interest rate. If your debts are with different lenders, these will be brought under one lender. You can consolidate several debts, including personal, business and car loans, tax debts, and credit card bills, into your home loan.

What should you consider before consolidating debts into your mortgage?

Ideally, debt consolidation will allow you to regain control over your finances. However, there are several factors you need to consider before deciding whether consolidating debts into your home loan is the right choice. Here are some of them:

1. Interest rates

When combining debt into your home loan, you need to make sure that your mortgage interest rate is lower than those on the other loans or you may end up with higher repayments.

2. Break and set-up fees

Refinancing your mortgage to consolidate debt may require you to pay several fees. A break fee, for instance, applies when you decide to refinance within the fixed period of the home loan. Most of the time, homeowners on fixed-term contracts face higher costs for breaking the loan. Because of this, experts advise waiting until the fixed period ends before refinancing, especially if the break cost is too high. New lenders may also charge a range of upfront fees, including loan application fee for the new loan.

3. Payment terms

Home loans typically have longer terms compared to other debts, so it is best to check if you will actually end up saving money down the line. A lower interest rate may seem appealing at first but may cost you more in the long run, especially if your mortgage is stretched out over 20 to 30 years.  

What are the benefits of home loan debt consolidation?

Consolidating debt into your home loan can yield several benefits. These include:

  • Paying a lower interest rate since home loan rates are often lower than those of other debts like personal loans and credit cards.
  • Better management of your debts as you only have one regular repayment to keep track of.
  • Improved cash flow and budgeting.
  • Less paperwork and other time-consuming procedures as you will be dealing with just one lender.

What are the drawbacks home loan debt consolidation?

Like any financial strategy, refinancing to consolidate your debts into your home loan has its share of disadvantages. Here are some of them:

  • While the interest rate on your home loan may be significantly lower than the rates on your other loans, the interest may accrue for an extended period as your mortgage also have a longer term.
  • Upfront and break costs can set you back a few to several thousand dollars.
  • Applying to refinance when you have a bad credit score will likely result in a rejection, which will hurt your rating further.
  • You may need to pay lenders mortgage insurance if your loan-to-value ratio shifts above 80% as a result of the debt consolidation.

An important thing to remember is that debt consolidation is just one way of helping you better manage your finances. It is not the answer to all your financial issues. Getting out of the debt cycle entails careful assessment of your spending habits, working out what you are doing right, and avoiding the things that can put you in a deeper hole.

If you are considering refinancing your mortgage to consolidate debt, it best to consult a qualified mortgage broker, who can give you sound advice that suits your financial situation.

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