What is a debt consolidation mortgage? And is it right for you?

Managing debts with high interest rates can feel like an uphill struggle. Monthly debt payments can take over a large chunk of your income, and it can feel like it will take forever to pay off the amount you owe.

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For example, if you carry a balance on your credit cards, you could typically be paying 19.99% in interest. If you owed $5,000 on a high-interest credit card, the annual interest would be $999.50. If you only paid $150 off your credit card every month, only around $67 would go towards paying off the amount you owe. It would take you over four years to pay it off in full, and you would end up paying $2,357 in interest.

Similarly, personal loans and lines of credit, payday loans and auto loans can all add financial stress. Juggling so many debts and paying so much in interest can make it difficult to get ahead financially. This is why homeowners often choose a debt consolidation mortgage. 

A debt consolidation mortgage: a definition

A debt consolidation mortgage is a way of cashing in some of your home’s equity, by increasing your mortgage. This additional amount would then be used to pay off all of your high-interest debts.

It is effectively a mortgage refinance, (a way to remortgage your house to pay off debts), which you can take out with either your current lender or a different financial institution. Your new mortgage will have a new principal amount (how much you owe) and could also have other new terms, such as a different interest rate and new prepayment privileges (these are the amounts of principal you can pay off on top of your normal mortgage payments).

You can consolidate a line of credit into a mortgage and you can also add credit card debt into a new mortgage. Here are some of the kinds of debts that you could consolidate with a mortgage refinance:

  • Credit card balances
  • Outstanding lines of credit
  • Auto loans
  • Personal loans
  • Payday loans
  • Second and third mortgages
  • Student loans

The pros and cons of a debt consolidation mortgage

For people who are carrying high interest debt that they’re struggling to pay off, a debt consolidation mortgage is a very useful financial tool, with some key advantages, including:

  • You pay considerably less interest on your debt.
  • You reduce your monthly debt payment amount to one that is far more affordable.
  • Several loans are consolidated into one easy payment.
  • You can lower your monthly outgoings and so reduce your financial stress.
  • The amount you owe will be reduced according to your mortgage’s amortization (the length of time it will take to pay off your mortgage).

There are some disadvantages, however:

  • Your new mortgage rate may be higher than your old one.
  • The terms of your new mortgage may be different from your old one.
  • There are costs involved with a debt consolidation mortgage.

Costs could include an appraisal fee, legal fees and a prepayment penalty (if your mortgage term isn’t up).  

How much money (and stress) you could save by refinancing debt

Most forms of debt have higher interest rates than the best available mortgage rates. Credit cards are the most obvious example, with many Canadian cards charging 19.99% or even higher.

Payday loans can charge the equivalent of over 400% in annual interest. Auto loans can charge as much as 10% in interest, and even personal lines of credit can charge interest above 10%, depending on your credit score.

Below, we’ve outlined an example of how much you could save in interest by remortgaging your house to pay off debts. This example also shows how you can reduce your monthly debt to far more manageable levels, thereby reducing a lot of financial stress.

In this example, our borrower takes on a debt consolidation mortgage of $30,000 (having previously paid off their mortgage). The new mortgage will have a fixed interest rate of 4.5% on a five-year term, with a 15-year amortization.

That $30,000 will be used to pay off the following debts:

$10,000 in credit card debt     19.99% interest     Paying interest only 
$10,000 in personal line of credit 9% interest    To be paid off over 10 years
$10,000 in an auto loan   7% interest    To be paid off over seven years

These are the details of the interest being paid on the three debts and the monthly debt payments involved, compared to the mortgage refinance:

  Total interest paid over five years  Monthly debt payment
Credit card      $9,995  $167   
Personal line of credit      $1,967  $116
Auto loan    $1,913 $151
Total $13,875  $434
Mortgage refinance 
($30,000)
$5,587  $229

As you can see, with a debt consolidation mortgage, you would pay over $8,000 less in interest, over a five-year period. Your monthly debt repayments would also be almost halved. These kinds of savings can really help anybody struggling with high interest debt and help them to have less stressful finances.

There is a small downside to this arrangement: with the debt refinancing outlined above, you would pay only $7,875 in principal (the amount owed), whereas with the previous loan agreements you would have paid off $12,143 in principal. Given that you would have saved over $8,000 in interest payments, however, you could put some of those savings towards paying off more of the principal owed.

How to work out how much you could borrow when refinancing debt

Many mortgage lenders will, in principle, lend up to 80% of the value of your home, minus the outstanding mortgage. Here’s an example:

Value of home  Outstanding  mortgage Extra amount available with a refinance
$600,000  $200,000  $280,000

You wouldn’t necessarily want to borrow that much extra money (your new debt would leap from $200,000 to $480,00), nor would you necessarily qualify for that much. When you apply for a debt consolidation mortgage, you still have to prove that you can afford to make the mortgage payments on the increased amount (lenders do this through their debt service ratios). 

How to apply for a debt consolidation mortgage

When you’re looking to remortgage your house to pay off debts, it’s like applying for a new mortgage. If you choose a new lender, you will have to supply them with some or all of the following details:

  • Current mortgage statement
  • Proof of income (T4s, notices of assessment, paystubs)
  • Property tax details
  • List of current debt obligations
  • Appraisal (if needed)

If you decide to stay with your previous lender, you may not have to provide this information, depending on how much extra you hope to borrow. However, you’ll still have to engage a lawyer to register the new mortgage.

Your chosen lender will let you know how much extra they’re willing to lend you, along with the terms and conditions (including the interest rate, prepayment privileges, etc.). If you switch lenders mid-term (before your current mortgage is up for renewal) you will have to pay a prepayment penalty. This can cost thousands of dollars, so it can often be advisable to wait to take a debt consolidation mortgage when it comes up for renewal.

How you’ll receive the funds

Many lenders prefer that funds are used to pay off your outstanding debts directly (this is often done by your lawyer). This way, they know for sure that your debts are paid off and your debt service ratios are all in line.

If there are any remaining funds owed to you, these will be paid to you directly, either by cheque or bank transfer, usually by your lawyer. 

Is a debt consolidation mortgage right for you?

You should discuss your plans to refinance debt with your IG advisor. They’ll be able to put you in touch with an IG Mortgage Planning Specialist and, together, they’ll be able to work out whether a debt consolidation mortgage makes sense for you, and the best way to go about it.

If you don’t have an IG advisor, you can find one here

 

 

Disclaimer
Investors Group Trust Co. Ltd. is a federally regulated trust company and the mortgagee. Mortgages are offered through I.G. Investment Management, Ltd.* Inquiries will be referred to a Mortgage Planning Specialist (in Ontario, a Mortgage Agent, and in Quebec, New Brunswick and Nova Scotia, a Mortgage Broker). 

*In ON and NS, registered as a Mortgage Brokerage (ON 10809, NS 3000240) and a Mortgage Administrator (ON 11256, NS 3000232), in QC, registered as a financial services firm (QC 2400376104) and in NB, registered as a Mortgage Brokerage.

 

Written and published by IG Wealth Management as a general source of information only, believed to be accurate as of the date of publishing.  Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice.  Trademarks, including IG Wealth Management and IG Private Wealth Management are owned by IGM Financial Inc. and licensed to its subsidiary corporations. Insurance products and services distributed through I.G. Insurance Services Inc. (in Québec, a Financial Services Firm). Insurance license sponsored by The Canada Life Assurance Company (outside of Québec).