What Canadian’s Should Know About Debt Consolidation and Refinancing

 

For a lot of Canadian’s today, one of the biggest hurdles to financial security is paying off their debt. Unfortunately, because of how easily we can acquire debt – credit cards, lines of credit, auto loans, home equity loans – for many this task feels more daunting than ever – especially when working on a fixed budget. The problem is becoming so big in fact that the average household in Canada owes $171 for every $100 in disposable income.

This has led many Canadian’s to turn to debt consolidation. A process of combining all of your household’s high-interest debt into a single low-rate monthly payment. This can do wonders for households on an already tight budget and has proven to provide homeowners with more flexibility and motivation to continue to strive for financial health. In fact, Canada’s housing wealth increased by more than $175 billion in 2016 thanks in large part to the benefits of debt consolidation.

 

To put it simply, debt consolidation can offer a number of benefits including

Improve your credit score:
Reducing your monthly bills will allow you to make every payment in full and on time. Over time, this will boost your credit score over time, giving you even more options in the future. Having a good credit score is vital if you have long-term goals that require a loan approval, like renovating your home, or getting a new car.

 

Take the Complexity Out of Your Finances:
Debt consolidation also eliminates the need to keep track of multiple bills with different amounts and varying due dates. It also removes the stress of late fees and over-limit charges on credit cards and personal loans. The more straightforward and consistent your payments are, the less likely you’ll be to miss one, or not be able to pay it in full. Having several payments to keep track of makes it significantly more challenging to pay each one on time each month.

Reduce Your Monthly Payments:
Combining your debts into your mortgage can actually lower your monthly payment by extending your payback period. This can be a great option, for those who want to pay back their debt at a steady pace.

Reduce Your Interest Rate:
Since your debt consolidation loan is backed by a real asset (your home), you will qualify for a lower interest rate than what you would likely get should you consolidate your debt without rolling it into your mortgage. This is because these loans are considered less risky in the eyes of the lender, which allows you to obtain easier payback options.

Repair credit:
Borrowers who are in financial distress or facing potential bankruptcy can get back on their feet with a consolidation loan. This allows you to keep your home and remain solvent.

How Exactly Does Homeowner Debt Consolidation Work?
As a homeowner, debt consolidation allows you to refinance your existing first mortgage with a debt consolidation mortgage. A refinance loan allows you to borrow additional money on your mortgage to pay off high-interest debt with a single low-interest monthly payment.

Some refinance options allow homeowners to borrow additional money on their mortgage to consolidate unsecured debts. This scenario, however, is a little different as homeowners borrow additional funds on top of their mortgage, leaving them with one simple monthly payment. These debts don’t become a “separate” mortgage; they are packaged with your existing one to give you one mortgage and one monthly payment.

Although debt consolidation isn’t the right choice for everyone, under the right circumstances it can translate to big savings.

While the criteria for obtaining a debt consolidation loan varies based on lender, successful applicants typically have reliable employment income. A steady employment history is also crucial as it provides the lender with confidence in your ability to pay the loan back. Homeowners with a higher credit score and no judgments or collections in their credit history will also fare better with low-interest loans.

So Who Should Apply for a Debt Consolidation Loan?

The point of a debt consolidation loan is to pay down your loans at a lower interest rate through a single monthly payment. By achieving a lower interest rate, a larger portion of your monthly payment will go to paying down your balance, helping you get out of debt much faster.

Debt consolidation can also lower the amount you pay each month by extending the amount of time you have to pay it back. You should consider applying for a debt consolidation loan for the following reasons:

  • You have spoken with a financial or debt advisor and determined that debt consolidation is the right choice based on your circumstances.
  • You are facing financial hardship, such as the loss of a job, an illness or other emergencies.
  • You are struggling to keep up with monthly payments on your unsecured debt due to higher interest rates.
  • You have tried managing debt payments in other ways, such as downsizing your current lifestyle to cut down your spending, selling some of your assets to finance debt repayments or asking for a loan from trusted friends or family members.
  • You are on a fixed monthly budget.
  • You have accumulated large equity in your home.

I’m a Homeowner, What are My Options?

First Time Homeowners
Homeowners may opt to refinance their existing mortgage with a debt consolidation mortgage. A debt consolidation mortgage allows you to borrow additional money on top of your already existing mortgage so that you can consolidate other debt into one simple payment at a lower interest rate.

It is crucial for homeowners to realize that this means the size of your existing mortgage will increase since you are adding other loans on top of it. That said, your overall monthly payment will be lower than it was when you were paying off your other debts individually. This option also gives borrowers the flexibility of having to make only one payment each month.

Refinancing allows homeowners to consolidate all other unsecured debts. One way of looking at it is that you are essentially getting a new mortgage and taking the equity on your home at the same time. However, by doing this, you are also breaking your existing mortgage contract, which may involve paying additional interest payments or service fees.

Second Mortgages
Borrowers with a low credit score or who have less than 20 percent equity in their home generally qualify for a second mortgage. In this case, borrowers can access up to 80 to 85 percent of the appraised value of their home. However, this depends on where exactly they are located, as well as the homeowners level of income and quality of the security. The 80 to 85 percent ratio usually applies to real estate in large urban centers. For real estate in rural locations, the ratio is usually capped at around 75 to 80 percent of the home’s value.

It is important to know that second mortgages are often seen as a short-term solution until the borrower’s first mortgage matures. Once this happens it allows them to combine the two mortgages together. Until that happens, you will be paying both your first and second mortgage simultaneously.

A Blended Mortgage
Blended mortgages allow homeowners to also take advantage of lower interest rates without paying the penalties of breaking their existing mortgage. This essentially allows homeowners to ‘blend’ or combine their mortgages. Rather than breaking their existing mortgage, homeowners can decide to keep it in the new blended rate. This allows them to avoid all the penalties that are associated with a typical mortgage refinancing.

It’s also important for homeowners to be aware that blended mortgages carry a penalty in the form of higher interest rates. The penalty is then “blended” in the form of a premium rate since the borrower is usually getting a non-triple A bought-down interest rate. Although this may be a suitable option for borrowers with low equity, homeowners with higher equity may find it more useful to break their existing mortgage, pay the penalty and enter a new mortgage with more favorable terms.

For its many benefits, debt consolidation also carries risks that homeowners must carefully weigh out before going down this route. The primary risk involved is losing your home in the event you default on your debt consolidation loan.

If you don’t do your due research and shop around for the best services, you could also end up paying much higher fees. In order to avoid these risks, it is imperative to make all your payments on time. This applies to both the consolidation loan and any other unsecured debt that you currently have.

If you have any questions please feel free to contact us