Debt Consolidation Through Re-Financing

Some homeowners choose re-financing in order to consolidate all their existing debts. With this choice, the homeowner can consolidate higher interest debts such as credit card debts under a home loan interest which is lower. The interest rates which are associated with home loans are usually considerably lower than the rates linked with credit cards. Choosing whether or not to re-finance in order to consolidate debt is a rather intricate issue. There are many complex factors which might enter into the equation as well as the existing debt amount, the interest rate difference as well as the difference in loan terms and the homeowner’s current financial situation.

This article will try to make this issue less complicated by giving a function definition for debt consolidation and giving an answer to two main questions homeowners should ask themselves before they opt to re-finance. Included in these questions is whether the homeowner will pay more in the long run by consolidating his debt and will the homeowner’s financial situation get better if they do re-finance.

What is Debt Consolidation?

The term debt consolidation is in itself somewhat misleading. When a homeowner re-finances his home in view of consolidating his debt, he isn’t actually consolidating the debt in the exact sense of the word. To consolidate debt by definition means to unite or to combine debts into one system. This is not however what truly happens when debts are consolidated. The existing debts are in fact repaid by the debt consolidation loan. Despite the fact that the total amount of debt remains constant, the individual debts are paid back by the new loan.

Preceding the debt consolidation, the homeowner might have been repaying a monthly debt to one or more credit card companies, an auto lender, a student loan lender or any other kind of lenders but now the homeowner is repaying one debt to the mortgage lender who gave him the debt consolidation loan. This new loan will usually be subject to the applicable loan terms as well as interest rates and repayment period. Any terms associated with the individual loans won’t be valid any longer as each of these loans has been fully repaid.

Will You Be Paying More in the Long Run?

When you choose to consider debt consolidation, it is important to determine whether lower monthly payments or an overall increase in savings is being looked for. This consideration is important because while debt consolidation can lead to lower monthly payments, when a lower interest mortgage is obtained to repay higher interest debts there isn’t always an overall cost savings. This is due to the fact that the interest rate alone doesn’t determine the interest rate amount. The debt amount as well as the loan term, or length of the loan, will prominently show in the equation too.

For instance, consider a debt with a rather short loan term of five years and an interest which is only slightly higher than the rate which is linked to 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 extended 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 that in the long run, the homeowner might end up paying more. Nevertheless, the monthly payments might be substantially reduced. This type of decision will force the homeowner to choose between overall savings or lower monthly payments.

Will Re-Financing Improve Your Financial Situation?

Homeowners who are thinking about the possibility of re-financing for debt consolidation purposes should carefully consider whether or not their financial situation will be improved through re-financing. This is important as some homeowners might choose to re-finance as it increases their monthly cash flow even if it doesn’t amount to any savings. There are many mortgage calculators available on the Internet which can be used for such purposes as finding out whether or not monthly cash flow will increase. Making use of these calculators and consulting with industry experts will help the homeowner to make a better and more informed decision.

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