What you need to know about refinancing for debt consolidation

If you already have a home loan, and also owe money on credit cards, personal loans or car loans, you may be figuratively drowning in debt. Juggling the repayments on multiple loans can be challenging at the best of times, and if your financial circumstances were to suddenly change, such as if you lost your job or suffered a prolonged illness, you could be at real risk of defaulting on one or more debts.

One option that may be worth considering is to refinance your mortgage and consolidate your debts as you do so. By combining your smaller debts and adding them onto your home loan, you may be able to better organise your finances and enjoy more affordable monthly repayments.

Juggling the scheduled repayments for multiple debts can be time-consuming and exhausting, even for well-organised and budget-conscious borrowers. And if any of these lenders charge variable interest rates, some (but not all) of your repayments could rise or fall from month to month, further complicating your budget.

By consolidating your debts when you refinance your mortgage, you’ll end up with just the one ongoing repayment to manage per month, massively simplifying your household budget. Even if your variable interest rate was to rise or fall, it should be relatively simple to account for just the one changing repayment.

The short answer is that refinancing for debt consolidation may reduce your monthly repayment totals, which can help to relieve some of your short-term financial pressure. But by paying off relatively small debts over a longer period of time, you may ultimately pay much more in interest charges over the full term of the loan.

The longer answer is that when you add up the principal and interest costs of making separate repayments on your various personal loans, credit cards and other debts, the combined monthly total can be surprisingly high.

By refinancing your mortgage and consolidating your smaller debts into it, you’ll only need to make the one repayment per month. You’ll also only be charged interest the once, most likely at a significantly lower rate than what might have been charged on your other debts. This can drop the monthly cost of your debts significantly, making them more affordable from month to month.

However, while consolidating your debts into a refinanced mortgage can help to relieve some of your financial pressure in the short term by minimising your monthly repayments, this doesn’t mean that refinancing for debt consolidation is a cheaper option in the long run than paying off your smaller debts separately.

This is because while home loans tend to have lower interest rates than personal loans or credit cards, their loan terms are typically much longer, with 25 or 30 years being common. This means that a borrower may ultimately pay significantly more in total interest over the lifetime of the loan than if they’d paid off their credit card debts and personal loans separately. 

Consider this hypothetical example (totals and interest rates are examples only, do not include fees or charges, and are not indicative of current market rates):

Before debt consolidation:

After debt consolidation

So, while you’d be paying over $720 less per month by consolidating your debt in this example, you’d ultimately pay over $28,000 more in total interest than you could by keeping your debts separate. 

• Beware of switching costs: Find out whether you will be charged any fees from your existing or future lender for consolidating your debts into a refinanced mortgage. One possible option is to consolidate these costs into your mortgage along with your other debts, though this would mean paying interest on these fees for the full term of the loan, ultimately costing you more in total.
• Try not to fall back into debt: It may take some heroic willpower, but once you’ve consolidated your existing debts into a refinanced home loan, don’t use this as an excuse to max out your credit cards again!
• Consider the ongoing fees: Refinancing involves taking out a brand-new home loan, and many lenders charge fees as well as interest on their mortgages, which can sometimes make them less affordable than you first thought. It’s worth checking your lender’s comparison rate to get a more accurate estimate of your refinanced loan’s approximate cost, including interest and standard fees and charges.

Ultimately, your choice of whether to consolidate your debts by refinancing your home loan comes down to whether the more affordable monthly repayments are worth paying more money in total interest in the long term. Before making any decisions, consider seeking independent advice from a financial adviser, who can take your unique financial situation and personal goals into account.

Once you’ve looked at the current cost of paying off your debts, compared to the ongoing costs of consolidating those debts into a refinanced mortgage, and are satisfied with how much you’d be paying back over the full term of the loan, it’s time to take the next step.

It’s often worth checking with your existing mortgage provider to see if they’d be willing to refinance your loan, though not all lenders offer a debt consolidation option. Comparing other lenders with the help of RateCity can give you a wider array of refinancing options to consider, increasing the likelihood of ultimately consolidating your debts into a single, easy to manage mortgage with an affordable interest rate.