Some homeowners choose to refinance to consolidate their existing debt. With this type of option, homeowners can consolidate high-interest debt, such as credit card debt, under a low-interest home loan. The interest rates associated with home loans are usually much lower than those associated with credit cards. Deciding whether or not to refinance for debt consolidation can be a rather tricky issue. There are many complex factors that enter into this equation, including the amount of existing debt, differences in interest rates, and differences in loan terms and the homeowner’s current financial situation.
This article will attempt to make the issue less complicated by providing a functional definition of debt consolidation and answering two key questions homeowners should ask themselves before refinancing. These questions include whether the homeowner will pay more in the long run by consolidating their debt and whether the homeowner’s financial situation will improve if they refinance.
What is debt consolidation?
The term debt consolidation can be somewhat confusing because the term itself is somewhat deceptive. When a homeowner refinances his debt in order to consolidate it, he is not actually consolidating it in the true sense of the word. By definition, consolidation means joining or combining into one system. However, this is not what actually happens when debt is consolidated. The existing debt is actually repaid by the debt consolidation loan. While the total amount of debt remains the same, the individual debts are repaid by the new loans.
Prior to debt consolidation, a homeowner may have made monthly payments to one or more credit card companies, auto lenders, student lenders, or any other lender, but now the homeowner makes one debt payment to the mortgage lender providing the debt consolidation loan. This new loan will be subject to the terms of the applicable loan, including the interest rate and repayment period. Any terms associated with the individual loans are no longer in effect because each of these loans has been repaid in full.
Will you have to pay more in the long run?
When considering debt consolidation, it is important to determine if you want to lower your monthly payments or increase your overall savings. This is an important consideration because while debt consolidation can result in lower monthly payments when obtaining a lower interest rate mortgage to pay off higher interest rate debt, it does not always result in overall cost savings. This is because the interest rate itself does not determine the amount of interest to be paid. The amount of debt and the term of the loan, or the length of the loan, also play an important part in this equation.
As an example, consider a debt with a relatively short loan term of five years that has an interest rate that is only slightly higher than the interest rate associated with a debt consolidation loan. In this case, if the debt consolidation loan has a term of 30 years, the repayment of the original loan would be extended to 30 years at an interest rate that is only slightly lower than the original rate. In this case, it is clear that the homeowner may end up paying more money in the long run. However, the monthly payment may be significantly lower. This type of decision forces the homeowner to decide if the overall savings or the lower monthly payment is more important.
Will refinancing improve your financial situation?
Homeowners who are considering refinancing for debt consolidation should carefully consider whether their financial situation will improve as a result of refinancing. This is important because some homeowners may choose to refinance because it will increase their monthly cash flow, even if it does not result in overall cost savings. There are many mortgage calculators available on the Internet that can be used for purposes such as determining if monthly cash flow will increase. Using these calculators and consulting with industry experts will help a homeowner make an informed decision.