What is Debt Consolidation?

Definition of Debt Consolidation

Debt consolidation is a means of combining several debts into one debt that has one monthly payment.

The goal of a debt consolidation is to lower the monthly payment and/or the interest rate of your total debt. If you have several high interest credit card debts and other loans outstanding, you may combine these debts into a second mortgage or home equity loan, making one payment to the second mortgage holder or lender.

Example

Mr. McGillicuddy has $60,000 in equity in his home. He also has the following outstanding debts:

Credit Card 1 - $10,000 balance - 15% interest rate - $350.00 monthly payment
Credit Card 2 - $ 8,000 balance - 17% interest rate - $300.00 monthly payment
Car Loan - $12,000 balance - 10% interest rate - $253.00 monthly payment
Line of Credit - $15,000 balance - 15% interest rate - $353.00 monthly payment
Total $45,000 - $1256.00 monthly payment

Mr. McGillicuddy can borrow $45,000 against the equity in his home in the form of a second mortgage or home equity loan. The lender will pay off each of the other loan holders, and home owner will have no further obligation to them. Based upon a 5% interest rate and a 30 year amortization period, homeowner will pay approximately $240.00 per month. In this case the drop in the monthly payment to the homeowner will be more than $1,000.00.

Unfortunately second mortgages and home equity loans are not always available in all provinces. In this case, Mr. McGillicuddy would have to look at completely refinancing his mortgage.

Advantages of Debt Consolidation

If a homeowner has equity in their home, and significant high interest debts, debt consolidation can save a great deal in monthly payments, as well as money spent in interest. In the example given previously, the homeowner eliminated 4 monthly payments totaling $1,256.00 to one payment totaling $240.00. Because the interest rates are usually lower than a credit card or signature loan, you may end up paying less over the life of the loan.

Disadvantages of a Debt Consolidation

If a homeowner does not have much equity in their home, debt consolidation is more difficult to obtain, and will usually be at a higher interest rate. If the homeowner is in a precarious financial situation and cannot make the monthly payment on the debt consolidation mortgage, it makes little sense to consolidate. If the outstanding debts are already at a low interest rate, and are short term, consolidation may actually cost the homeowner more money.

At First Foundation, we have a great deal of experience in structuring debt consolidation mortgages for our customers. We will be happy to review your current financial situation to determine if a debt consolidation mortgage is right for you.

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Last updated Jul 17, 2014