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Should You Consolidate?
Is debt consolidation a smart move, or just a band-aid that trades several repayments for one? In this article, I’ll walk you through how it works and the pros and cons worth thinking about.
Credit cards, personal loans, car finance and other debts can build up over time, leaving you with several repayments coming out at different times and often at very different interest rates.
Using your home loan to consolidate some of those debts can look like an obvious way to simplify things. One repayment may be easier to manage, and the interest rate on a home loan will often look much more attractive than the rate attached to a credit card or personal loan.
There are situations where that can work really well. There are also some important trade-offs worth looking at more closely.
Before we recommend going down that path, we want to understand what putting those debts into the home loan actually changes and whether it leaves you in a better position overall.
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What Actually Happens When You Add Debt Into Your Mortgage
The mechanics are fairly simple. You increase the amount owing on your home loan, either by refinancing to a new lender or increasing the loan with your existing one, and use the extra funds to pay out some or all of your other debts.
So if you had a home loan alongside a credit card and personal loan, those separate balances may be paid out and the amount owing on the mortgage increases instead. The consolidated debt is now sitting within the home loan. You’re left with fewer repayments to manage and, in many cases, a smaller repayment overall.
That last part is important. Credit cards and personal loans are usually unsecured, while a home loan is secured against your property. So moving those debts into the mortgage changes the repayment and interest rate, as well as the structure and security behind the debt.
We don’t really think of this as “clearing” the debt because that’s not what’s happening. We’re just moving it somewhere else. For that to be worthwhile, the new structure needs to improve the overall position rather than simply make the debt look tidier.
Are You Reducing the Debt or Just Stretching It Out?
Let’s pull back the curtain and see what’s really going on. This is where debt consolidation can look better than it really is.
Let’s say you have a credit card or personal loan balance and you want to move it into your mortgage. On the face of it, moving this debt into the mortgage may give you access to a lower interest rate and a lower regular repayment. That can create useful breathing room, especially when several repayments are competing for the same household income.
The problem comes when debt that was meant to be paid off over a few years gets converted into long-term debt and sits inside the mortgage for decades.
Say you had $20,000 of debt at 18% and were repaying it over five years. On a simple principal-and-interest example, you’d repay around $30,500 in total.
Move that same $20,000 into a home loan at 6.5%, and the rate looks dramatically better. If that portion of the debt then sits there for 25 years, though, the total repayments would be around $40,500.
That’s an intentionally simplified example and doesn’t include fees, rate changes or other loan costs. The point is that a much lower interest rate can still produce a higher overall cost when the debt is stretched out for long enough.
This is why we don’t judge a consolidation refinance from the monthly saving alone. We want to know what happens to the debt after settlement, how quickly that portion will actually be repaid, and what it could cost over that period.
If we’re turning debt that might otherwise have been gone in a few years into part of a 20 or 30-year mortgage, there should be a deliberate reason for doing it. Otherwise, we may have improved the repayment without really improving the debt.
There Still Needs to Be Room in the Budget
Consolidating debt into your mortgage usually means increasing the amount secured against your home. So before we get too far into rates and repayments, we need to know whether there’s enough room for the extra borrowing, both against the property and within your household budget.
For example, if your home is worth $700,000 and you owe $500,000, that doesn’t automatically mean you have $200,000 available to use. The lender will have limits around how much of the property value it’s prepared to lend, and the larger home loan still needs to work with your income, expenses and other commitments.
The relationship between the property value and the amount being borrowed is expressed as the loan-to-value ratio, or LVR. If increasing the loan pushes the LVR too high, the consolidation may simply stop being workable with some lenders. Lenders Mortgage Insurance, or LMI, can also come into the picture at higher LVRs, and its added cost can make debt consolidation unviable.
Naturally, we can see why this gets missed when the focus is on bringing the repayment down without considering what else changes along with it.
Does Consolidation Actually Improve the Situation?
Before we recommend consolidating debt, we need to understand your financial situation.
The debt structure may be the problem, or the repayment pressure may be coming from somewhere else. Either way, we need to know what we’re dealing with before adding more debt against the home.
There may be a short-term reason debt has built up, such as a period of reduced income, an unexpected expense or another one-off event that is temporarily stretching the household budget. If that period has passed and things have stabilised, restructuring the remaining debt can give the borrower some breathing room. In those circumstances, accepting a potentially higher long-term cost in exchange for more manageable repayments now may be a worthwhile option.
In other cases, debt might grow because there has never been enough room in the household budget. That gives us a very different situation to work with.
If we refinance today, pay out credit cards and increase the mortgage, then those cards start building up again six months later, we haven’t really solved the problem. We may have simply replaced the original debts with a larger home loan and a new round of unsecured debt on top.
There’s no judgement in asking how the debt got there. We just need to know because it helps us work out whether consolidation is likely to change the position or simply reset the balances for a while, and whether there’s an advantage to doing so.
Consolidating Everything Isn’t the Only Way to Create Repayment Relief
When someone comes to us because several repayments are becoming difficult to juggle, we don’t automatically assume every debt belongs in the mortgage.
There may be a better reason to consolidate some debts and leave others exactly where they are. A high-interest credit card might be worth dealing with, while a car loan that is already well into its term could make little sense to stretch out over the home loan. Another debt may be able to be restructured on its own without touching the mortgage at all.
This is why we look at each debt individually. We want to understand what it costs, how much is left, how long it has to run and what the repayment is doing to the household budget. From there, we can compare different ways of creating relief rather than defaulting to one big consolidation.
That might mean consolidating only the debts causing the most pressure, restructuring another loan separately, or leaving a debt alone because the existing arrangement already makes sense.
The objective isn’t to manufacture the lowest possible repayment next month. We want the overall position to improve. If we can create enough breathing room without dragging every debt into the mortgage, that may be the better outcome.
Don’t Let the Debt Disappear Into the Mortgage
If debt consolidation does make sense, the next question is how we structure it.
One option is to refinance the home loan, where the existing mortgage is replaced with a new, larger loan and the additional funds are used to pay out the debts being consolidated. Another option may be to increase the existing home loan with the current lender, depending on what they allow and whether the existing loan is still worth keeping.
What we don’t want is for short-term debt to simply disappear into one large mortgage balance.
If $20,000 of credit card or personal loan debt is moved into a home loan with 25 years remaining, there’s no reason that $20,000 automatically needs to take 25 years to repay. Where the loan allows it, keeping the consolidated amount in a separate split can make it easier to see what is still owing and set a more deliberate repayment timeframe.
That may mean paying that portion down faster while leaving the rest of the mortgage on its normal schedule.
If we’re going to move short-term debt into the home loan, we want to make a conscious decision about how it gets repaid rather than letting the mortgage term make that decision for us.
Final Thoughts
Debt consolidation can be a useful way to create repayment relief, but we don’t decide whether it makes sense from the new interest rate or repayment alone.
We look at what you owe now, how the debt built up, what the refinance would actually change and whether there may be a better way to restructure some or all of it.
If you’re considering consolidating debt into your home loan, we can look at the whole position and help you work out whether it’s likely to leave you better off.
Tom is the founder of BrightCredit and a finance broker focused on borrowing situations that are not straightforward. His writing helps Australians understand credit, loans, and the details that can affect their borrowing options in a clearer, more practical way.