The General Thought
- Obviously, debt consolidation programs simply shift the debt and do not address the underlying reason for the debt.
- If the client has equity in their home, it creates options to clean up their balance sheet and improve cash flow.
- Improved cash flow can be used to reduce the increased mortgage balance or to invest further for their future.
Considerations
Debt consolidation programs work well for the client when applied as follows:
- First obtain a home equity loan or home equity line of credit (HELOC), or address debt consolidation at mortgage renewal time.
- From the new mortgage/loan proceeds, payout high-interest debts, thereby reducing overall monthly debt servicing costs (increase cash flow).
- Make regular mortgage/loan payments, plus...
- Re-direct all (or a good portion of) the newly created excess monthly cash flow back against the loan balance.
Properly used, debt consolidation allows the borrower to direct a greater percentage of each debt repayment dollar towards reducing the debt balance vs. to high interest thereby accelerating repayment.
| Example # 1 (before remortgaging) |
| Current Situation |
Balance |
Payment |
| Mortgage (5.99%) |
$150,000 |
$959.00 |
| Unsecured Line |
$10,000 |
$300.00 |
| Credit Cards/Loans |
$20,000 |
$600.00 |
| Penalty/Tax Bill/Other |
$2,500 |
$0.00 |
| Total |
$182,500 |
$1,850 monthly |
Below is scenario after remortgaging and paying off those debts.
| New Mortgage |
Balance |
Payment |
| Mortgage (3.49%) |
$182,500 |
$959.00 |
| Unsecured Line |
Paid off |
$0.00 |
| Credit Cards/Loans |
Paid off |
$0.00 |
| Penalty/Tax Bill/Other |
Paid off |
$0.00 |
| Total |
$182,500 |
$959 monthly ($891 less) |
Note that the mortgage balance has increased by $32,500 and the client's monthly cashflow has improved by $891. By redirecting the $891 back against the new mortgage/loan balance, the non-mortgage debt component can be paid out in about 3 years. Had the consumer debts averaged 15% interest, the time frame to eliminate the debts would have been 4 years (holding the monthly payment constant). The strategy has saved the client $10692 in interest.
From a mortgage planner's point of view,
- Debt consolidation is a tool to manage the client's debt-servicing-ratio - to allow the applicant to juggle their financial affairs to meet certain objectives.
- For example, recently clients wanted to purchase a second home (condo) for their son to occupy while he attended university, but their consumer debts prevented them from qualifying for a second mortgage. A debt consolidation refinance cleaned up their consumer debts, lowered their debt-to-income ratio, and provide surplus funds for the required down payment. They succeeded with their 2nd home objective.
If you or your client, friends or associates have any questions on this or any mortgage situation or need, please feel free to contact us.
If you own your own home, have at least 20% equity, and think you can mortgage qualify, please feel free to schedule a review and planning session.
