Can you convert a personal loan to a home loan?

If you are juggling multiple debts, one way to simplify your finances is by consolidating your debts into a single loan. Converting from a personal loan to home loan can result in a more affordable single loan under certain conditions, though it’s important to compare your options and make some calculations first.

Converting your personal loan into a mortgage will likely require you to effectively refinance your home loan. The amount of extra money you’ll be able to borrow (sometimes known as “topping up” your home loan) to consolidate your personal loan debts will depend on your lender, your financial circumstances, and how much usable equity you have available in the property.

Benefits of debt consolidation

Debt consolidation can make it easier to manage your finances. Under the right circumstances, it also has the potential to save you money in the long-term, as you may be paying interest at a lower rate, or paying fewer fees. 

When multiple debts are consolidated into a single loan, it can make repayments easier to manage. With a little financial discipline, you may be able to repay your money faster using this strategy.

Some other potential benefits of converting a personal loan to a home loan include:

• Your repayments may reduce if you get an affordable home loan interest rate.
• You may be able to improve your cash flow and enhance your savings.
• Less stress from managing multiple loans. 

Risks of debt consolidation

Converting your personal loan to a home loan may also have certain risks or disadvantages, such as:

• There is a risk of losing your home if you are unable to make timely payments.
• Home loans have longer loan terms than most personal loans, so even if the interest rate is lower, you may pay more interest on your consolidated debt than paying off your smaller loans separately over shorter terms.
• Your loan to value ratio (LVR) increases when you add your personal loan balance to a home loan, which may lead to you paying a higher interest rate.
• If your LVR increases to more than 80% of the property value, you may have to pay the additional cost of Lenders Mortgage Insurance (LMI).
• Some lenders may charge setup fees for the new consolidated home loan package.
• Increasing the mortgage on your home may limit how much of your equity you can easily access.

How does debt consolidation work?

A debt consolidation home loan may not be available to all borrowers. The lender must be confident that you are financially capable of repaying the consolidated debt while also staying in control of future borrowings to receive approval. The amount that can be consolidated varies from one lender to another.

Some factors that lenders will assess when you apply for debt consolidation may include:

• Timely repayment of your home loan during the previous six months
• Good credit history
• Stable employment history
• No missed repayments
• Timely payment of credit card bills and personal loan instalments for the last three months
• Strong financial situation that could improve your ability to make timely payments on the consolidated debt. 

How will consolidating debts affect my credit score?

Consolidating debts won’t ruin your credit. If you’re able to consolidate other debts into your home loan, this can reduce the chance of late or missed repayments, potentially helping to improve your credit score over time.

That said, because refinancing a mortgage (even with the same lender) means effectively taking out a new home loan, the lender will likely conduct a hard credit check, which will be recorded in your credit file. If you’ve recently been applying for credit elsewhere, too many credit enquiries over a short period could risk damaging your credit score.

Keep in mind that if you’re consolidating your debts because you’ve been struggling to manage your repayments, you may already have a poor credit score. While you may still be able to consolidate your personal loans into your mortgage, you may also be charged a higher interest rate if your credit record isn’t the cleanest.

Also, paying off outstanding loans could lead to a dip in your credit score, such as if these were your oldest credit accounts and your credit history shortens when they’re closed. But as long as you make repayments on your consolidated debt on time, these positive credit behaviours could help to rebuild your credit score.

How to convert your personal loan to a home loan

The exact process of consolidating your debts into your home loan, including your personal loan, may vary depending on your lender and your exact financial circumstances. The general process may require taking the following steps:

1. Collect the details of your home loan, your personal loan and other debts, as well as your property’s value.
2. Estimate what your LVR may be if you added your personal loan debt to your home loan. If the LVR will be more than 80%, you may need to calculate the cost of LMI.
3. Collect documentation, such as payslips and bank statements, as proof of income and expenses.
4. Contact your mortgage lender about refinancing your home loan and consolidating your personal loan debt. This will require going through many of the same steps as applying for a mortgage e.g. checking your income and expenses and conducting a formal valuation of your property.
5. If approved, the lender will pay the extra cash into your nominated bank account, which you can use to clear your outstanding personal loan debt.
6. Pay off and close your personal loan account.

Keep in mind that there may be application fees and other upfront charges you’ll need to pay when refinancing to consolidate debt. Additionally, making an early exit from your personal loan could also mean paying extra charges in some cases. Check if the potential value of consolidating your debts would make up for any extra costs you may be charged.

For additional advice and support when refinancing, whether or not you’re consolidating debt, a mortgage broker may be able to guide you through the process and support you when making your application.

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