Debt Consolidation Calculator

Debt Consolidation Done Right

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Is debt consolidation a good idea?  It depends.

What is the best way to do it?  That also depends.

Many of my clients have asked me to arrange a debt consolidation loan.  Some of them have gone about it in the wrong way, in my opinion, and it has cost them money.  Let’s take a look at when it makes sense, and how best to do it, depending on your circumstances.

Why is debt consolidation on everyone’s mind?

Carrying Excess Debt is Stressful
There are solutions. Photo by Mikhail Nilov from Pexels

Americans are taking on more debt – lots of it.  According to a recent study by NerdWallet, total U.S. household debt increased by 6.2% from a year ago to a total of $15.24 trillion.  Yikes.  Breaking it down we can see some interesting patterns.

Credit card debt (or revolving debt) has decreased by almost 14% from a year ago.  Apparently, some folks used their stimulus payments well in this regard.  Auto loans increased by 6.10%, so some of that stimulus money went towards down payments for new cars.  Mortgage debt increased by 8.22%.  This is probably a combination of new home purchases (rising prices means larger mortgages) and debt consolidation as well.

But not all is well.  35% of Americans say household finances are worse than 1 year ago.  18% of Americans relied on revolving debt for necessities and 17% relied on revolving debt for emergencies.  Rising interest rates mean interest costs and payments on revolving debt will rise moving forward.

The cost of living is rising faster than wages, so these trends will likely get worse.  The progress made on paying down revolving debt in the last year will probably reverse.

The good news (for homeowners, anyway) is that there is a lot of equity in homes now, and that conforming loan limits had their biggest increase in years for 2022.   Conforming loans have easier underwriting requirements and generally lower interest rates and costs than non-conforming, or “jumbo” loans.  So, refinancing to consolidate debt is easier and cheaper than ever.

Advantages of Debt Consolidation

Ease stress through debt consolidation
Ease stress – debt consolidation
Photo by Mikhail Nilov from Pexels

The most obvious advantage to a debt-consolidation loan is lower monthly payments.  Most folks use this as a benchmark to determine if they are saving money, but that’s too simple and could mislead you into making a mistake.  We’ll explore that in a minute, but first there are some clear benefits to debt consolidation.

Generally, a debt consolidation loan will reduce the amount of interest you are paying.  If you use a cash-out refinance to consolidate credit card debt this is definitely true, as interest rates on revolving debt are always higher than mortgages.  The interest rate on mortgages is also usually a fixed rate, where credit card interest rates can vary every month, and are almost certain to go up this year.

Consolidating your debt into a mortgage will also mean much lower payments.  This tends to be the shiny object that convinces most homeowners to do it.  The lower payments result partially from the lower overall interest cost, but also because you are extending your debt.  This may not be a good thing, but you can correct for that; more on that in a moment.

Consolidating your debt into a single loan also simplifies your life.  You’ll have only one bill to pay each month.

When you consolidate your debt into one mortgage, it is possible that your interest may become entirely tax-deductible.  This varies considerably by individual, so if this is the reason that compels you to consolidate, consult with your tax advisor before you move forward.

Costs and drawbacks of debt consolidation

Debt consolidation into a new mortgage will generate costs.  Yes, you can get a no-point, no-fee mortgage, but that doesn’t mean there are no costs.  You can finance these costs into your new mortgage if you have enough equity, or you can have the lender pay for them by taking a higher interest rate, but there are costs.

Deeper dive: What is a no-cost mortgage?

In almost all cases, by consolidating your debt into a new mortgage you’ll extend the repayment term of the debt, and may actually pay more over your lifetime as a result.  If you have 25 years left to pay on your mortgage, and you refinance into a new 30-year mortgage, you’ve just added 5 years of payments on to the back end of your loan.  (We’ll discuss how to manage that in a minute.)

Revolving debt, on the other hand, will usually be paid off in 5 to 7 years if you make the minimum payment, so when you consolidate that into a new mortgage you’ve added 23 to 25 years to the term.  Even at a much lower interest rate, your lifetime costs will be much higher.

Finally, some folks are very comfortable carrying credit card debt, and after consolidating into a new mortgage run their credit cards up again.  Some folks.  If this is you, it may be better to not do a consolidation loan.

Who should consolidate debt?

If you have high revolving balances and you’ve reached the point where you simply barely have enough income to meet your monthly obligations, do a debt consolidation loan.  While the drawbacks described above still apply, struggling to make your bills is stressful and could impact your health and well-being.  By all means do what you have to in order to avoid getting back in the same position, but a debt-consolidation loan could be a very bright move.  This is especially true if you are in danger of missing payments.  Once you do, your new mortgage will be much more expensive, if you qualify at all.  Consolidate your debt before you get into deeper trouble.

If you aren’t in trouble yet, but you can foresee getting there, and you have a good plan to stay out of expensive debt moving forward, then you should consolidate your debt.

If you have plenty of equity in your home a debt consolidation loan may make sense for you.  You still should have a plan to stay out of high-cost debt in the future, and a plan to pay off the new loan at least as fast as the mortgage you are replacing, but a debt consolidation loan can reduce your interest costs, lower your monthly payments, ease your stress, and probably save you money in the long run.

Debt consolidation options

To consolidate debt using your home equity, you have three basic options, plus one which doesn’t use your equity:

  • Refinance your existing mortgage and your other debt into one new mortgage
  • Keep your existing mortgage and use a home equity loan to consolidate your other debt
  • Keep your existing mortgage and use a home equity line of credit
  • Use a personal loan from your bank to consolidate your debt

There are advantages and disadvantages to each option.  Specifically,

Strategy Comments Benefits Drawbacks
Refinance into one loan If you can refinance without increasing your current interest rate, this is very attractive. Single payment

Best option as to the interest rate

 

May lose current low interest rate

Upfront costs are highest

 

Home Equity Loan Good option if you don’t want to refinance your current mortgage Lower cost than refi

Still can save money

 

Higher interest rate than refi

Higher payment

May not be tax-deductible

Home Equity Line of Credit Good option if you want flexibility Very flexible – Pay it off and use it again

Interest-only – Lower payment

Very low upfront cost typically

Variable interest rate

I/O payments mean you are not paying it down

 

Personal Loan Usually no cost up front

Your home not collateralized

Highest interest rate

Highest payment

Should you consolidate your debt?

If you are currently stressed about your debt load, then yes, absolutely.

If your current situation is due to unexpected expenses, like a medical emergency, and you are not normally prone to running up high revolving debt, then yes.

If you can lower your monthly payments and intend to use your savings to invest and build your retirement fund or reserves, then probably.  If this is you, you are simply using one asset (your home equity) to help build up your other assets.  Consult with your financial advisor on this.

If you ran up your credit card balances spending more than you earn, a debt consolidation loan may not be the best option for you in the long run.  You might be better off cutting up your credit cards, cutting back on spending, and focusing on paying down your debt.

Bottom line

Debt consolidation calculator
How much can you save?

The debt consolidation decision should not be taken lightly.  Done thoughtfully, it can certainly solve problems, save money, and ease stress.  Done carelessly it could simply make your troubles worse.  So, consult your family, consult your financial advisor if you have one, and then consult an experienced, competent and ethical mortgage advisor who will help you work through the pros and cons and find you the best alternative.

Want to explore how the numbers work for you?  Try this free debt-consolidation Excel analysis.  It’s free, and you don’t have to give us your personal information to use it.  We’re just really nice people.

Casey Fleming, Mortgage Advisor  NMLS 344375

Loanguide@Outlook.com (408) 348-3442

Resources used for this article:

Nerd Wallet Household Debt Survey

This article represents the opinions of Casey Fleming, and not necessarily those of Fairway Independent Mortgage Corp.  This analysis was prepared with the best information available at the time it was written.  Neither Casey Fleming, nor Fairway Independent Mortgage Corp., have any magical insider information about bond markets, real estate markets or mortgage markets that would make economic projections any more reliable than any other source.  No warranty is made that the outcome will reflect the projections in this article, and neither Casey Fleming nor Fairway Independent Mortgage Corp. are responsible for decisions that you make regarding your own choices about your real estate or mortgage or those of your clients.

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