Re-Financing to Consolidate Debt. Useful Information to Keep in Mind

Posted on July 24, 2009
Filed Under Debt Consolidation | Leave a Comment

Some homeowners choose to re-finance to consolidate their existing debts. With this category of opportunity, the homeowner can consolidate higher interest debts such as credit card debts under a lower interest home loan. The interest rates associated with home loans are usually lower than the rates associated with credit cards by a considerable amount. Deciding whether or not to re-finance for the purpose of debt consolidation can be quite complicated subject. There are numerous complex factors which enter into the equation including the amount of existing debt, the difference in interest rates as well as the difference in loan terms and the present financial situation of the homeowner.

This article will attempt to make this issue less complex by providing a function definition for debt consolidation and providing answer to two major questions homeowners should ask themselves before re-financing. These questions incorporate whether the homeowner will pay more in the long run by consolidating their debt and will the homeowners financial situation get better if they re-finance.

What is Debt Consolidation?

The term debt consolidation can be a bit confusing because the term itself is somewhat deceptive. When a homeowner re-finances his home for the purpose of debt consolidation, he is not in fact consolidating the debt in the true sense of the word. By definition to consolidate means to unite or to combine into one system. But, this is not what actually happens when debts are consolidated. The existing debts are in fact repaid by the debt consolidation loan. Though the total amount of debt remains constant the individual debts are repaid by the new loan.

Prior to the debt consolidation the homeowner may have been repaying a monthly debt to one or more credit card companies, an auto lender, a student loan lender or any number of other lenders but now the homeowner is repaying one debt to the mortgage lender who provided the debt consolidation loan. This latest loan will be subject to the applicable loan terms including interest rates and repayment period. Any terms connected with the individual loans are no longer valid since each of these loans has been repaid in full.

Are You Paying More in the Long Run?

When considering debt consolidation it is critical to determine whether lower monthly payments or an overall increase in savings is being sought. This is an principal consideration as while debt consolidation can lead to lower monthly payments when a lower interest mortgage is obtained to repay higher interest debts there is not always an overall cost savings. This is since interest rate alone does not establish the amount which will be paid in interest. The amount of debt and the loan term, or length of the loan, figure prominently into the equationtoo.

As an example consider a debt with a relatively short loan term of five years and an interest only slightly higher than the rate connected with the debt consolidation loan. In this case, if the term of the debt consolidation loan, is 30 years the repayment of the first loan would be stretched out over the course of 30 years at an interest rate which is only slightly lower than the original rate. In this case it is clear the homeowner might end up paying more in the long run. Though, the monthly payments will probably be radically reduced. This category of decision forces the homeowner to decide whether an overall savings or lower monthly payments is more principal.

Does Re-Financing Improve Your Financial Situation?

Homeowners who are considering re-financing for the point of debt consolidation should carefully consider whether or not their financial situation will be improved by re-financing. This is significant for the reason that some homeowners may opt to re-finance since it increases their monthly cash flow even if it does not result in an overall cost savings. There are many mortgage calculators available on the Internet which can be used for purposes such as determining whether or not monthly cash flow will increase. Using these calculators and consulting with industry experts will help the homeowner to make a well informed decision.

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