Consolidating other debts such as a car loan or a large credit card bill into a mortgage is one of the most common reasons for home loan refinancing in Australia. We look at how this works and whether or not it’s a good idea.
Aussies are familiar with being in debt, having among the highest ratios of household debt to income in the world. Going by the latest OECD data, we have the fourth-highest, behind Denmark, Netherlands, Norway and Switzerland.
It seems to be surging even higher, with the RBA’s ratio hitting a record high of 190.5% in June 2018.
So what makes up this debt? The ABS’s Household Income and Wealth survey for 2015-16 reported the following average outstanding debt levels for indebted households:
- $203,700 on mortgages (owner-occupied plus other property loans)
- $3,700 on credit cards
- $4,100 on car loans (excluding business and investment loans)
- $2,000 on other personal loans (excluding business and investment loans)
And how are we coping with all this debt? Not too well it seems.
Digital Finance Analytics estimates that around one million Aussie households are suffering from mortgage stress. Meanwhile, ASIC reported in July 2018 that 18.5% of consumers are struggling with credit card debt – that’s 1.9 million people.
Given this prevalence of debt in Australia, there’s a relatively high chance that your desk-buddy at work or the guy next to you on the train are struggling with their own debts.
Debt can be a vicious cycle too; those who have it sometimes take out more debt to cover their debts, leading to more long-term debts.
So what can you do to manage it?
Debt consolidation refinancing – how it works
Many homeowners try to organise their debts by refinancing their home loan to consolidate them into it. Generally, this involves packaging all of your existing debts (e.g. credit cards, car and personal loans etc.) into your mortgage, so that all your debts are gradually paid off through the one monthly/fortnightly/weekly mortgage repayment.
Let’s take a look at how this works.
Guy’s debt consolidation
Guy is facing a mountain of debt at the moment from his mortgage, his credit card and the car loan he took out recently. He takes a look at all of his debts and puts them together to work out exactly how much he’s paying each month.
|Debt type||Amount owed||Minimum Monthly repayments|
|Mortgage (4% interest rate)||$300,000||$1,848|
|Credit card (17% interest rate)||$5,000||$125 (at 2.5% of the balance)|
|3-Year Car loan (10% interest rate)||$10,000||$323|
Given that Guy’s monthly pay is $4,525 after tax ($70,000 gross salary), his total debt repayments account for over half of that. When he factors in his rent, utility bills, groceries and other costs like transport, he doesn’t have much left to save.
Guy speaks to his lender about refinancing his home loan to consolidate his debts. He’s five years into his 25-year $350,000 mortgage, with $300,000 remaining. Since he has a strong equity position (with an LVR of under 80%), his lender agrees to add the $15,000 of credit card and car loan debt to his mortgage and refinances him to a $315,000 25-year mortgage at the same interest rate of 4% p.a. His monthly repayments now look like this:
|Debt type||Amount owed||Monthly repayments|
|Debt Consolidated Mortgage (4% interest rate)||$315,000||$1,663|
Under this new debt consolidation loan, Guy’s monthly repayments have now been reduced by $633 to $1,633, giving him some much-needed breathing room at the end of every month.
However, with his loan term extended back to 25 years (he had 20 years remaining before he refinanced), he will pay significantly more in interest over the life of the loan, unless he makes additional repayments when he’s in a better position.
The case for consolidating your debts
Based on the example above, refinancing your home loan to consolidate your debts can save you money in the short term (if you do it right).
It can also be much easier to just have one loan to repay. Making repayments to three, four or five different lenders can mean more paperwork, more time and more stress, so cutting these extra stakeholders out can make it easier to sort out your finances.
The case against
This strategy definitely isn’t foolproof. Perhaps the biggest drawback to consolidating smaller debts into your mortgage is that you’re stretching these short-term debts over a much longer term. While the interest rate on the mortgage may be significantly lower than the rates on the credit card or car loan, the interest will be accruing over a much longer period. The general rule is longer loan term = more interest costs – this is why making extra or more frequent repayments can reduce how much you pay.
You should also take into account the upfront costs of refinancing, which can set you back thousands. If you’re struggling with debt, chances are you might not be able to afford these costs.
If you’re experiencing financial hardship and have a poor credit rating, many lenders actually might not allow you to refinance your home loan to consolidate debts. If things have taken a turn for the worse, you can call the National Debt Helpline on 1800 007 007 to talk through what your options are.
You’ll need equity in your home
In order to refinance your existing home loan into a new one that allows you to consolidate your debts, you will need to have some built up equity in the property.
Because of the extra risk you may present, lenders will look to the value of the property to determine your equity, and they’ll usually allow you to borrow up to 80% of the value of the property. The more of your mortgage you’ve paid off already, the higher your chances of being approved for a favourable new loan.
How do you actually refinance your home loan in order to consolidate debt?
Refinancing might seem complicated, but it’s a pretty simple concept: you either change to a different loan with your existing loan provider or switch to a new provider with more favourable terms.
Contact your current lender first about your desire to consolidate your debts with a new home loan. If they aren’t willing, you could try contacting other lenders. Home loans are a competitive market right now, and there is no shortage of options out there that could have better interest rates, fees, features and lending conditions than what you might have now.
You can use Loans.com.au’s home loan repayments calculator to calculate mortgage repayments and compare the total costs of different loans. This can help you decide whether or not it’s worth refinancing.
Savings.com.au’s two cents
Debt consolidation is not a magic pill that magically removes all of your problems – it’s just a way for you to better manage your debts.
Unless you change your spending behaviour, you may not ever get out of the debt cycle. Work out how you got yourself into this predicament and what you can do to prevent yourself from falling deeper into the debt hole.
Something to be aware of as well is that some lenders might try to charge you a higher interest rate when refinancing. This might be because all of your extra debts make you appear to be a higher risk, but choosing such a loan could be disastrous. A loan that’s even a few basis points higher could cost you thousands of extra dollars by the end. Make sure you also ask the lenders what the refinancing costs will be and what their ongoing fees are.
Before you consolidate, you should also consider less-drastic debt management methods. Many money experts around the world advocate for the ‘snowball’ or ‘domino’ method of focusing on paying off debts one at a time, starting with the smallest debt, while making the minimum repayments on the other debts. This method plays into psychology – the borrower gains more confidence in their debt-repayment abilities after the “quick wins” of paying off the smaller debts, motivating them to tackle the bigger debts.
Another method is the ‘avalanche’ strategy of paying off the debts with the highest interest rates first, which can save you more in interest but can be psychologically harder than the ‘snowball’ method.