We recently had a borrower who had over $110,000 of consumer debt (credit cards and personal loans).
The borrower had a very low fixed-rate mortgage too that we could not match because rates have gone up and because the borrower’s credit score had dropped so much because of the consumer debt.
BUT – the borrower refinanced anyway into a 1/4% higher rate because he was able to reduce his total payments by almost $3,500 per month.
This is because we consolidated ALL of his debt into a single mortgage.
The borrower had a plan to pay off his consumer debt over a five-year period because he wanted to keep his low mortgage rate.
But, our offer to help him save over $40,000 per year made refinancing into a higher rate the obvious choice.
Refi Again After Credit Score Goes Up
Another advantage of debt consolidation loans is credit improvement.
The borrower above will likely see his credit score increase by as much as 100 points over the next six months.
And, because credit scores influence one’s interest rate significantly, he will likely be able to refi again into a lower rate even if rates climb a bit more.
Why Debt Consolidation Works So Well
1. Short-Term to Long-Term Debt
Debt consolidation with a mortgage refi works so well because it allows borrowers to convert short-term, high-rate consumer debt into long-term (30 years), low-rate mortgage debt.
Some clients get overly concerned about extending out their debt maturities, but we remind them that if they invest even a portion of their savings, they will be far better off financially in just a few years.
The benefit for the borrower in my above example is almost immediate.
2. Tax Deductible
Another benefit of debt consolidation is the fact that the interest on mortgage debt is often tax deductible, subject to some limitations (so all clients should discuss this with their tax advisors).
3. Appreciation
A final reason debt consolidation loans work so well now is appreciation. Because properties have appreciated so much in recent years, most borrowers with consumer debt have a substantial chunk of equity they can easily dip into to pay off their debt.
Debt Consolidation = Cash Out Loan
All debt consolidation loans require “cash out loans” or refis that involve increasing principal balances.
LTV Limits
Cash out loans have stricter Loan-to-Value ratio limits but they are still very flexible.
Conforming refis can go up to 80% LTV, as can FHA and some jumbo refi’s.
Higher Rates
Cash out loans also have higher rates in most cases too, unless the LTV is very low (under 60% for example).
But, we still offer cash out loans in the mid-3% range for both conforming and jumbo loans.
Cost/Benefit – Rule of Thumb?
Unfortunately, there is no rule of thumb for deciding on whether or not to obtain a debt consolidation loan.
It really comes down to net monthly savings and how fast a borrower can pay off her consumer debt without a debt consolidation loan.
If a borrower has a very low fixed-rate and can pay off her consumer debt in less than a year or two, she probably should keep her low-rate loan – and we will be the first to tell her as much.
BUT – if borrowers are unable to pay off their debt quickly or if their total payments are a financial strain – they should do a debt consolidation loan.
Most importantly, if borrowers are confused at all about what to do, they should contact Hannah Papazian at our office and she will walk them through the entire analysis.
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This blog is no exception of course and it may prove very valuable for many of their past clients who have taken on debt since purchasing a home.
