Taking a cash out mortgage for debt consolidation is a great idea – sometimes.
Life would be so much simpler if all your monthly payments were in one bill. Besides, your credit card balance has a 16.99 percent interest rate, and that car loan with $425 a month payments just seems outrageous. What can you do to get it all under control?
Well, some people turn to a debt consolidation mortgage. In fact, many people did that back before the mortgage crisis because lenders allowed homeowners to refinance and cash out as much as 110 percent of the value of their homes. That doesn’t happen anymore.
“In the mid-2000s, people used their house as a piggy bank. They were taking out home equity like it was nothing, and many of them got in to trouble,” says Scott Halliwell, certified financial planner with USAA, a Fortune 500 company serving the military and their families with insurance, banking, and investment products.
“If you do use home equity and then get more debt, you put your home at risk,” he says.
But he admits that sometimes life throws out unexpected things such as medical bills, and not everyone who needs debt consolidation do it because of bad debt.
“Through no fault of their own, sometimes people face a financial train wreck. Sometimes, debt consolidation loan can help them out,” he says.
But for those who got themselves into this financial trouble by racking up credit card debt to buy bigger and better things, then he warns that debt consolidation will not help unless bad spending behaviors and attitudes are changed.
“People can change. But that normally requires some kind of life change such as they get a second income with a spouse, they get an inheritance, or they get a new job with a big pay increase. Those events become the catalyst to fix their spending problem,” he says.
The first thing he suggests they do is call their current lender and get an amortization table. Many of these tables are available online now, too.
“It can be very valuable to start there and look at your current loans. You can figure out if you leave the current loan alone or you consolidate and how much it will cost you or save you,” he says.
He also said talking to a financial planner, your accountant or even someone in your family who understands finances is a good step to do before signing any new loans.
“At least this way, you are making some level of an informed decision. Know what the financial ramifications are instead of just knowing the payment plan,” he says.
Halliwell would only encourage someone to get a debt consolidation loan if it results in paying less interest over time. For instance, you probably wouldn’t want to consolidate a car loan that you’ve been paying on for four years and only have one year left.
“Most of the car payment is now going toward principal. You don’t want to stretch that back out to a 30 year loan,” he says.
Enrica Bustos, housing counselor at Adams County Housing Authority in Commerce City, Colo., feels that using the equity in your home to pay off credit cards is a bad thing.
“It’s just better to live within your means and pay off those credit cards one at a time,” she says.
She feels that the equity of your home should only be used in extreme cases such as your child gets sick and you need extra money, or something in your home needs repaired immediately, and it’s going to cost a lot.
“Everyone wants the biggest and best right off the start. That’s how so many get into financial trouble,” she says. “No one ever realizes that they can a can work up to that. Debt consolidation loans do allow people to pay off their credit cards. But they can use them again.”
Bustos has seen too many people never cut up those cards and then begin using them again till they max them out again.
“Instead of debt consolidation, I recommend doing a crisis budget. They need to pay off one credit card at a time. This way, they don’t touch the equity in their home,” she says.
When she works with clients and they are thinking about a debt consolidation loan, she talks with them about the extra costs they will incur especially by doing a refinancing loan.
“They don’t realize they will have to have another appraisal which costs money. They will have closing costs, too. Is paying $4,000 for closing costs to get $8,000 off of your debt really worth it?” she says. “The fine line about debt consolidation is that how will the person go forward. Will they charge up the card again?”