Re-Financing to Consolidate Debt
Some homeowners decide to re-finance to merge their existing debts.
With this type of option, 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
traditionally 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 a rather tricky issue. There
are a number of 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 current
financial situation of the homeowner.
This article will try to make this issue less confusing by providing
a function definition for debt consolidation and providing answer to
two key questions homeowners should ask themselves before
re-financing. These questions include whether the homeowner will pay
more in the long run by consolidating their debt and will the
homeowners financial situation improve if they re-finance.
What is Debt Consolidation?
The term debt consolidation can be somewhat puzzling because the
term itself is a bit deceptive. When a homeowner re-finances his
home for the purpose of debt consolidation, he is not actually
consolidating the debt in the true sense of the word. By definition
to consolidate means to unite or to combine into one system.
However, this is not what actually happens when debts are
consolidated. The existing debts are actually repaid by the debt
consolidation loan. Although 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 supplied
the debt consolidation loan. This new loan will be subject to the
applicable loan terms including interest rates and repayment period.
Any terms associated with the individual loans are no longer valid
as each of these loans has been repaid in full.
Are You Paying More in the Long Run?
When considering debt consolidation it is vital to determine whether
lower monthly payments or an overall increase in savings is being
required. This is an important consideration because 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 because interest rate
alone does not determine 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 equation as well.
As an example consider a debt with a fairly short loan term of five
years and an interest only somewhat higher than the rate associated
with the debt consolidation loan. In this case, if the term of the
debt consolidation loan, is 30 years the repayment of the original
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. However, the monthly payments will probably be
drastically reduced. This type of decision forces the homeowner to
decide whether an overall savings or lower monthly payments is more
important.
Does Re-Financing Improve Your Financial Situation?
Homeowners who are considering re-financing for the intent of debt
consolidation should cautiously consider whether or not their
financial situation will be improved by re-financing. This is
important because some homeowners may opt to re-finance because 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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