Some homeowners choose to re-finance to merge their existing debts. With this
type of option, the homeowner can consolidate higher interest debts such as
credit card debts under a lower interest home loan. The interest rates
associated with home loans are traditionally lower than the rates associated
with credit cards by a considerable amount. Deciding whether or not to
re-finance for the purpose of debt consolidation can be a rather tricky issue.
There are a number of complex factors which enter into the equation including
the amount of existing debt, the difference in interest rates as well as the
difference in loan terms and the current financial situation of the homeowner.
This article will try to make this issue less difficult by providing a function
definition for debt consolidation and providing answer to two key questions
homeowners should ask themselves before re-financing. These questions include
whether the homeowner will pay more in the long run by consolidating their debt
and will the homeowners financial situation improve if they re-finance.
What is Debt Consolidation?
The term debt consolidation can be somewhat confusing because the term itself is
rather deceptive. When a homeowner re-finances his home for the purpose of debt
consolidation, he is not actually consolidating the debt in the true sense of
the word. By definition to consolidate means to unite or to combine into one
system. However, this is not what actually happens when debts are consolidated.
The existing debts are actually repaid by the debt consolidation loan. Although
the total amount of debt remains constant the individual debts are repaid by the
new loan.
Prior to the debt consolidation the homeowner may have been paying off a monthly
debt to one or more credit card companies, an auto lender, a student loan lender
or any number of other lenders but now the homeowner is repaying one debt to the
mortgage lender who provided the debt consolidation loan. This new loan will be
subject to the applicable loan terms including interest rates and repayment
period. Any terms associated with the individual loans are no longer valid as
each of these loans has been repaid in full.
Are You Paying More in the Long Run?
When considering debt consolidation it is vital to determine whether lower
monthly payments or an overall increase in savings is being required. This is an
important consideration because while debt consolidation can lead to lower
monthly payments when a lower interest mortgage is obtained to repay higher
interest debts there is not always an overall cost savings. This is because
interest rate alone does not determine the amount which will be paid in
interest. The amount of debt and the loan term, or length of the loan, figure
prominently into the equation as well.
As an example consider a debt with a somewhat short loan term of five years and
an interest only slightly higher than the rate associated with the debt
consolidation loan. In this case, if the term of the debt consolidation loan, is
30 years the repayment of the original loan would be stretched out over the
course of 30 years at an interest rate which is only slightly lower than the
original rate. In this case it is clear the homeowner might end up paying more
in the long run. However, the monthly payments will probably be drastically
reduced. This type of decision forces the homeowner to decide whether an overall
savings or lower monthly payments is more important.
Does Re-Financing Improve Your Financial Situation?
Homeowners who are considering re-financing for the objective of debt
consolidation should cautiously consider whether or not their financial
situation will be improved by re-financing. This is important because some
homeowners may opt to re-finance because it increases their monthly cash flow
even if it does not result in an overall cost savings. There are many mortgage
calculators available on the Internet which can be used for purposes such as
determining whether or not monthly cash flow will increase. Using these
calculators and consulting with industry experts will help the homeowner to make
a well informed decision.