Paying off debt is a part of modern life. By borrowing money, we can unlock wealth-creation and lifestyle opportunities and ultimately lead more interesting and fulfilling lives.
However, not all debt is created equal. Some debt is good, and some is bad. Good debt allows you to cost-effectively purchase an appreciating asset and create a net gain for your wealth. Good debt is an investment. On the flip side, bad debt provides an opportunity for you to purchase a material asset or experience, however the debt’s conditions usually create a situation where you end up paying much more for it (via comparatively higher compounding interest rates and fees). Bad debt is a liability. Examples of ‘bad’ debt include:
- Credit cards
- Personal loans
- Car finance
- Microfinance apps like Zip Pay
In reality, many people have bad debt. And that’s not necessarily a bad thing. Some of us choose to pay more for something so we can experience it sooner.
However, what happens if your bad debts start to pile up, or their interest rates rise to a point where you struggle to reduce the principle of the debt?
In today’s article, I want to explore a strategy that may help you consolidate and reduce bad debts using the equity you have in your home or investment property.
The mechanics behind this strategy are quite straightforward: you borrow against the equity you have in your home (or another property you own) to reduce or eliminate some or all of your bad debts.
- Let’s say you have a couple of credit cards and a personal loan.
- Your credit cards have exceeded their interest-free period and you’re now paying about 19%p.a. in interest.
- Your personal loan’s interest rate is fixed at 9%p.a.
- Ouch. However, you have some healthy equity in your home, and you have a good credit rating.
- Instead of slogging away and paying these off at their original interest rates, you decide to borrow more from your home loan (at your home loan’s interest rate, which is usually much lower than 19% or 9%), pay them out, and close them.
This strategy allows you to pay off bad debt with a much lower interest rate, and provides a more convenient situation with less management of multiple repayments etc.
While this strategy might sound attractive, it’s not for everyone. You must have equity available, you must have a good track record with your bank and credit history, and you may need to satisfy other lending requirements. You will also need to consider:
- The impact on your credit rating. When you apply to extend your loan, it will be recorded on your credit rating. It may be risky to apply for more funds if your credit rating is damaged. I’ve provided more on this below.
- Interest rates. You must ensure that your mortgage’s interest rate is lower than the interest rate of the debt you’re paying out. With rising mortgage interest rates, this is particularly important to check (and future-proof, too).
- Fees. If you are required to break a fixed interest rate period to access extra funds, your bank may ask for additional fees. Depending on your bank, these fees may outweigh the benefits of consolidation (and you may be better off waiting until the fixed period ends). You may also need to pay application fees, or other fees, to access additional funds. If you’re unsure about this, feel free to reach out—we’d be more than happy to review your loan and provide assistance.
- Payment terms. It’s important to calculate your repayment details (and the longer-term impact of these extra repayments), to ensure that you’re not worse off by consolidating. This will require debt calculators and other nuanced tools. Again, if you’re unsure how to do this, feel free to reach out. Our powerful software tools will quickly provide answers specific to your situation.
Consolidating bad debt into your home loan can be a powerful and impactful strategy. However, you must also consider other factors, including:
- You may be required to pay LMI (‘lender’s mortgage insurance’) if you exceed a certain threshold of your LVR (‘loan-to-value ratio’). Or, your bank may not allow you to borrow to consolidate if you exceed this threshold.
- If you try to refinance when your credit scores are damaged (due to missed payments on your bad debts, or other causes), you may create even more damage to your scores. It pays to check with an expert before you do this (we can help here, too).
- As mentioned above, your bank may charge you fees for breaking fixed interest periods or accessing more money.
To summarise, consolidating bad debts into your mortgage can be an impactful strategy. However, the way in which you plan and execute this strategy will determine its success.
Can we help with your debt consolidation?
Assessing your current lending and equity situation, planning a debt consolidation strategy, and applying for additional finance isn’t an easy task.
If you’re looking for an expert team to help with your debt consolidation, request a 30-Minute Finance Strategy Session during which you will…
- Discover how to unlock the equity in your current property/ies, so you can access the funds you need to consolidate
- Discover clever, no-cost ways to save money on interest, fees, and charges — immediately (beyond your debt consolidation goals)
Get an up-to-date picture of the lending landscape including rates and conditions
- Learn about our process to find you more suitable loan conditions
This no-obligation session will be held with one of our experienced mortgage brokers.
Please be assured this will not be a thinly disguised sales presentation. On the contrary, you’ll receive our best strategic advice, specific to your situation, so you too can accumulate multiple properties without sacrificing your current lifestyle and accelerate your progress towards wealth.
Please note, the numbers and assumptions listed in this article are for educational purposes only. Individuals should seek specific advice pertaining to their unique situation and the real estate market before making any decisions.
Trilogy Funding Two is a corporate credit representative (Representative Number 506131) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237)