Debt Consolidation Loans

We have all heard the advertisements – "Consolidate your debts into one low payment". Do these "debt consolidation loans" make sense? For many consumers the answer is a definite "yes". However, as with any other financial undertaking you must analyze the benefits vs. the costs.

What is a debt consolidation loan?

Very simply, it is paying off consumer debt (credit cards, installment loans, car loans, etc.) and replacing it with a mortgage loan. Sometimes it may involve paying off an existing 1st and/or 2nd mortgage in addition to paying off the consumer debt.

What are the benefits to this type of loan?

There are numerous benefits to a debt consolidation loan, as follows:

Lower Monthly Payments – Consumer debt almost always has a higher interest rate than a mortgage loan, which translates into lower monthly payments on a mortgage loan.

Tax Deductibility – Mortgage interest is almost always a deduction you can take on your income taxes, while interest on consumer debt is not tax deductible. This could be a significant money saver come tax time. As with anything involving the federal tax code, there are a few exceptions that limit the deductibility of mortgage interest, so a call to your tax advisor or CPA may be appropriate.

One Monthly Payment – Some consumers are late on the consumer debt payments simply because they can not keep track of numerous payments.

Is a debt consolidation loan a first mortgage or a second mortgage?

A debt consolidation loan could be either a first mortgage or a second mortgage. If your existing first mortgage has an interest rate close to or below current market rates, it probably makes sense to maintain the existing first mortgage and utilize a second mortgage as the debt consolidation loan. On the other hand, if your existing first mortgage is above current market rates, a new first mortgage will probably be the best solution. A competent mortgage lender will be able to show you the various options.

What is the best way to determine whether a debt consolidation loan makes sense?

The suggested method to analyze a debt consolidation loan is to simply divide the amount of the Closing Costs by your monthly savings. This result will provide you with the number of months it will take for you to truly realize your monthly savings. And the benefit is actually better as we have not considered the tax savings in this simple analysis.

Example: The Closing Costs of the debt consolidation loan is $1,800. The monthly savings is $300 a month. We divide 1,800 by 300 and get 6. Thus, after 6 months we have recouped the $1,800 cost of debt consolidation loan, and every month after that is "pure savings".

What is the negative to a debt consolidation loan?

As with almost every mortgage loan, a debt consolidation loan usually requires payoff of the loan when you sell your house. This is unlike consumer debt that you carry with you if you move to another home. An issue could arise if the combination of all your mortgage debt is equal to or greater than the value of your home (i.e. you have no equity), and then you sell your home. Selling a home costs money (i.e. realtor commission) and if you have no equity, then you will have to bring "cash" to the closing table.

Want to apply for a debt consolidation loan? Click here to find out how.