Getting on top of your debt can be hard, but consolidating your debt could be your first step to getting debt-free.
We’ve talked about debt before, and there’s a reason for that: almost everyone has some amount of it. Having a small amount of consumer debt and owing money on your mortgage is totally normal. Unfortunately, however, sometimes life just happens. You can get hit with sudden medical bills, your car can break down, or any number of other unplanned - yet expensive - things can come up. Sometimes, the only way to deal with these situations is to take on debt, such as carrying a significant balance on multiple credit cards month-to-month. Emergencies are one of the responsible uses for a credit card, but with the high interest rate that usually accompanies them, credit card debt can rapidly spiral out of control. Monthly payments rack up, and just keeping track of all the different accounts owing can become a struggle in and of itself. This is where consolidating your debt can help you. Debt consolidation isn’t just a buzzword used by financial advisors in TV advertisements; it can be hugely beneficial to consumers with any amount of debt. Traditionally, to consolidate your debt what you do is take out a loan that is roughly the same size as your existing debts, and use that loan to pay those debts off. This might seem strange at first - why take on debt to pay off debt? The reason for this is that the debt consolidation loan will usually have a lower interest rate than the smaller debts being paid off, meaning you save money in the long-term. In the event that the loan you take out is somehow the same interest rate as all the debts being paid off, it at the very least simplifies your finances by giving you one payment to deal with each month. Consolidating your debt can even have the added bonus of improving your credit, as once you start chipping away at your outstanding accounts, your total credit utilization will go down, boosting your score.
Debt consolidation sounds fairly simple when laid out like that, but the hardest part is getting a loan big enough to pay off your other balances owing. If you owe a significant amount of money on multiple accounts, this can be a struggle, but there are a few tried and true ways of making it work. If you have enough equity in your home, you can refinance, take out equity, or apply for a second mortgage. These three options will almost always have a significantly lower interest rate than something like a credit card, and if your home has a high appraised value, these can be relatively simple ways of getting a loan large enough to pay off significant debts. There are some finer details of how the three options are different - for example, a home equity line of credit is technically a type of second mortgage, but functions similarly to a credit card - so when trying to determine which one is right for you, we always recommend talking to a mortgage broker. While some people would rather do anything else than owe more money on their home, current mortgage rates are beyond consumer friendly when compared to something like a credit card - the current prime rate* is 3.95%, compared to a credit card that can have an interest rate as high as 20%. No matter how much money you owe, a difference that large will be noticeable over any significant period of time, meaning that it can be in your best financial interest to consolidate your debt by using the value of your home.
Home equity loans, refinancing, and second mortgages are also not the only way to consolidate your debt. If you owe a significant amount of money, but that amount is lower than 40% of your gross annual income, you may be able to qualify for a debt consolidation loan through a bank or credit union. A debt consolidation loan is exactly what the name implies - a personal loan for consolidating your debt. These loans can be harder to qualify for, however. As previously stated you do need to owe less than 40% of your yearly income, and you will also need a strong credit score, and even then the lender may require some form of security. But if you do qualify for a debt consolidation loan, this can allow you to consolidate your debt and avoid owing more money on your home. One thing you will need to keep in mind when considering a debt consolidation loan is that it will usually have an amortization of three to five years. This means you will need to be able to pay off the entire loan in that time - and you will be making payments significantly higher than just the minimum payment on a credit card. If your heart is set on qualifying for a debt consolidation loan but your credit score isn’t high enough, we do have some recommendations for how to boost your credit score here.
One thing that is absolutely critical when consolidating your debt is that you remember that even if your debt is consolidated, you still have debt. A debt consolidation loan does not make your debt nonexistent, it just makes it less expensive and more manageable. It can be tempting following a consolidation to begin spending more, but this is the exact opposite of what you should do, as this can then lead to owing just as much high-interest debt as before, but now without the option to consolidate this new debt. Remember, debt consolidation is not a full solution in and of itself, it is just a strong first step to becoming debt-free. The best thing you can do after consolidating your debt is to take a look at what poor habits - if any - led to taking on the debt you had, and then making a conscious effort to adjust those habits. If it was purely unforeseen sudden expenses that led to taking on debt, then focus on saving as much as possible so that if something similar ever happens again, you’re more prepared. It’s impossible to plan for every eventuality in life, but finding where you can trim your expenses while still maintaining your quality of life can only be a benefit when the unfortunate happens.
Getting your debt under control takes work, but it’s doable. Even if your credit score isn’t as strong as it could be, there are proven methods to obtain financing at an affordable interest rate that will save you money in the long-term. Whether that takes the form of a debt consolidation loan, a second mortgage, or refinancing your home, there are options available to you as a consumer - and we want to help you. Get in touch with a member of the Essential Mortgage team, and we’ll do everything we can to help you consolidate your debt, and make your life just a little less stressful.
*Prime rate as of May 8, 2019
All information and offers herein are subject to change and available OAC