As the new year financial year nears, it can be the perfect time for many to take a closer look at their finances.
To get ahead, one of the most important things you can do is to cut down on your high-interest debts. For homeowners, a clever way to do this is with the help of debt consolidation.
Consolidating various debts into your home loan can be a strategic financial move that reduces your interest and allows you to pay the debt down faster. However, there are both advantages and disadvantages that you need to consider.
Advantages:
Lower interest rates: One of the advantages of debt consolidation is the potential for lower interest rates. Home loans typically offer significantly lower interest rates compared to unsecured debts like credit cards or personal loans. By consolidating these debts into your home loan, you can enjoy substantial savings over the long term. This not only reduces your monthly payments but also allows you to pay less interest over the extended repayment period.
Streamlined management: Managing multiple debts can be overwhelming, leading to missed payments and financial stress. Debt consolidation allows you to streamline your financial obligations into a single, easy-to-manage account. With just one monthly repayment, you can regain control of your finances and ensure timely payments, simplifying your financial landscape.
Fee reduction: Juggling multiple accounts often comes with various fees, such as account maintenance charges. Consolidating your debts into a single account can associated fees. This streamlined approach not only saves you money but also offers greater transparency in tracking your financial commitments.
Improved cash flow: Lowering your interest rates through debt consolidation translates to improved cash flow. With reduced monthly payments, you free up additional funds that can be redirected towards other financial goals. Whether you choose to spend, save, or invest, the increased cash flow provides financial flexibility and opportunities for wealth-building.
Disadvantages:
Home at risk: One significant drawback of debt consolidation using your home loan is the increased risk to your property. Converting unsecured debt into secured debt means offering your home as collateral. If you fail to make consistent repayments, you risk losing your home, making it crucial to prioritise timely payments to mitigate this potential downside.
Potentially higher interest: While the promise of lower interest rates is a key advantage, poorly structured debt consolidation loans may result in increased interest payments over the loan’s lifespan. Carefully consider the terms of the consolidation, especially the length of the repayment period, to ensure that you don’t end up paying more interest in the long run.
Refinancing fees: The process of debt consolidation often involves refinancing, which can incur additional fees. These may include setup fees, exit fees from existing loans, and application fees for the new consolidated loan. It’s essential to factor in these costs when evaluating the overall financial impact of debt consolidation.
Loan to Value Ratio (LVR) impact: Bundling existing debts with your home loan may impact your LVR. If this ratio exceeds 80%, you may be required to pay Lenders Mortgage Insurance (LMI), adding an extra cost to your financial obligations.
Reduced flexibility: Unlike unsecured debt loans that often offer flexibility in repayment frequency, home loans may come with limitations. Monthly repayments could be mandatory, and there might be charges for making extra repayments. This reduced flexibility could affect your ability to manage your repayments according to your preferred schedule.
The first step when weighting up debt consolidation is to speak to a mortgage broker who can look at your financial situation and compare your options.
