Using your mortgage to consolidate other debts such as personal loans and credit cards can often be a lifesaver.
No more juggling several monthly payments to different lenders and trying to meet the minimum repayments. A debt consolidation mortgage moves all of your debts in to one place, with just one monthly payment to worry about.
For many people the new monthly payment is less than they were paying to all of the different lenders. So why do all the lenders and brokers have a warning that debt consolidation mortgages will cost you more money?
How does that work?
Well, it’s because of the interest charges on a debt consolidation mortgage.
Let us explain…
What does debt consolidation mean?
Debt consolidation is the process of borrowing money that is then used to pay off other debts that you already have.
It is normally used as a way of streamlining the monthly payments to creditors, or to reduce the overall cost if the payments have become unaffordable.
You will find more useful information in our article: What does debt consolidation mean?
What is a debt consolidation remortgage?
Remortgaging is where you move your mortgage to a new lender, often to take advantage of a better interest rate deal.
A debt consolidation remortgage takes this one step further. When you apply to the new lender you ask to borrow more money so that this can be used to pay off other debts that you have.
You will have a larger mortgage but your monthly repayments are often lower than before.
So why do debt consolidation mortgages cost more?
It can seem counter intuitive at first.
Your mortgage is on a low interest rate and your monthly repayments are less than before.
How can this cost more?
Put simply, it’s because mortgages are arranged over longer terms than other debts. Typically, 20-30 years.
Although the interest rates are lower, you get charged interest over an extended period of time.
Let’s try and explain using some examples.
Unsecured debts
We will use a credit card and personal loan as part of the example. The loan was originally for £30,000 over 10 years, and has 7 years remaining.
| Personal Loan | Credit Card/s | |
|---|---|---|
| Interest rate | 6% | 16% |
| Amount owing | £22,799 | £10,000 |
| Monthly payment | £333 | £198 |
| Total paid over 10 years | £39,967 | £16,684 |
| Total interest due to be paid | £5,178 | £6,684 |
In this example the combined monthly payments are £531 and the interest due to be paid over the remaining 7 years is £11,862.
Consolidate the debts over 15 years
Now we will consolidate both the loan and credit card/s into a mortgage. This will be repaid over 15 years.
| Mortgage | |
|---|---|
| Interest rate | 5% |
| Amount borrowed | £32,799 |
| Monthly payment | £259 |
| Total paid over 15 years | £46,686 |
| Total interest due to be paid | £13,888 |
Consolidating the unsecured debts releases £272 of monthly expenditure. However, repaying the debts back over an extra 8 years has cost £2,026 in interest.
Extending the remortgage to 20 years
By extending the mortgage term to 20 years you can see how the cost changes.
| Mortgage | |
|---|---|
| Interest rate | 5% |
| Amount borrowed | £32,799 |
| Monthly payment | £216 |
| Total paid over 20 years | £51,950 |
| Total interest due to be paid | £19,151 |
Extending the term for a further 5 years costs an extra £5,263 in interest payable to the lender.
Now of course, none of these examples allow for a potential change in interest rates.
Is it still worth doing?
Whether debt consolidation is ‘worth it’ comes down to individual needs and circumstances.
Someone who is struggling to meet their monthly commitments would surely welcome the opportunity to simplify and reduce their credit payments each month.
Even if this means paying more interest later on.
If you are unsure about your options, speak with a debt adviser or mortgage broker, as they can explain the alternatives.
Debts you can consolidate
- Credit cards
- Store cards
- Personal loans
- Overdrafts
- Payday loans
Debts you shouldn’t consolidate
- 0% interest cards
- Loans that are nearly paid off
- Student loans
How does a debt consolidation re-mortgage work?
There are two elements to consider:
Remortgage
This involves applying for a mortgage with a new lender. You will need to choose the interest rate deal, repayment method and term. They will do all of the normal checks, such as; ID, income verification, affordability assessment etc.
Debt consolidation
All of your debts can be seen by lenders when they view your credit report. So you will need to tell the lender which debts are to be consolidated and how much extra you need to borrow to do this.
Once the new mortgage is ready, it will be used to pay off the mortgage you have now. The extra you have borrowed will be transferred to your bank account, so that you can then pay off the other loans and cards etc.
When consolidation may not be possible
Mortgages are highly regulated loans that are secured against your home.
The lenders are obliged to carry out a lot of checks before deciding to approve your application.
Here are some of the issues that could crop up.
Affordability and Creditworthiness: Lenders will look closely at your ability to repay any additional borrowing on top of your mortgage. If your financial situation doesn’t meet their criteria, they might not approve your consolidation.
Equity: To consolidate debts into your mortgage, you need to have enough equity in your property. This means the part of your property’s value that you own outright must be sufficient to cover the additional borrowing.
Loan-to-Value Ratio (LTV): Adding more debt to your mortgage increases your LTV ratio. If this ratio becomes too high, it might exceed the lender’s own limits, and they could reject your application.
Credit History: Your credit history is crucial in a lender’s decision-making process. If you have a poor credit history or a low credit score, this could lead to the rejection of your debt consolidation.
Changes in Your Circumstances: If there have been significant changes in your circumstances, such as a reduction in income or job loss, lenders may deem the increased borrowing as too risky.
Debt-to-income ratio: Debt to income forms part of affordability. If too much of your income is used for your debt repayments then lenders may reject your application.
Lender’s Internal Policies: Different lenders have their own policies for debt consolidation. Some might be more conservative than others in their lending practices.
Unacceptable Debt: Not all types of debts are suitable for consolidation. Lenders may not give approval for gambling debts or tax bills.
Can’t Borrow Enough: This could be due to affordability, LTV or equity. If you have a lot of unsecured debt then it may not be possible to borrow all of the money needed to repay it.
HOW A BROKER CAN HELP
Brokers are experts at solving mortgage related problems.
First, they can look at your overall debt position and do some calculations to see how worthwhile debt consolidation would be for you. They can work out the monthly costs and the interest charges for borrowing for longer.
Brokers are able to match you to a suitable lender. This decision will be influenced by your; occupation, earnings, debt-to-income, loan to value, equity and affordability. They will only choose a lender that has a high chance of approving your application.
They will then help you to apply for the new mortgage and deal with any issues that may arise while it is being assessed.
Ready to explore your options?
If you’re just about to start your mortgage journey and could use the guiding hand of a professional, don’t hesitate to reach out to a reputable mortgage broker.
An independent mortgage broker can access over 100 lenders on your behalf. They will make the process smoother and more profitable than going it alone.
Keep reading, keep asking questions. The more you know, the better decisions you can make.
