Consolidate Debt Risks

I started this article out by wanting to explain how to Consolidate Debt into your mortgage.  As I wrote and thought, I realised that I had travelled this path, had made it to the other side, and had some good insights. The issue was really not so much how do you do it; but should I do it, and is there a better way?

I speak from experience. I have consolidated a bucket load of debt into the mortgage, on more than one occasion. And I have taken other approaches. I have learned the hard way, but I have formed the conclusion that you should not consolidate debt into your mortgage.

One of the most popular methods of getting a handle on outstanding debt is to find out how to consolidate debt into a mortgage. This is a fairly simple process, but it is not without its risks, which I will outline below. Consolidating you debt into your mortgage carries a lot of benefits such as reducing the monthly payments on all your outstanding loans and creating momentum that will enable you to get free of debt faster.

In order to get this underway, you need to do the real basic things like prepare a budget and reduce your spending. There is absolutely no advantage in lumping all your unsecured debt onto your mortgage, not control your spending, and run a up a huge load of debt in addition to the existing debt, all because you could not change the behaviours that got you into the predicament in the first place.

How To Consolidate Debt

So how do you do it?  What is the best way to consolidate debt? After you have got your budget, you will know that you are spending say $2000 per month on your mortgage, and $2000 of the sum of your unsecured debts. You will need to talk to your bank about accessing the line of credit or redraw facility. You will need their approval. So go in prepared. Have your balance sheet ready, with your outstanding balances, monthly payments, annual interest rates etc.

If you have enough equity in your house, it is usually a straight forward process to consolidate debt. Perhaps a valuation of your home is required. You will need to get up to the minute payout figures, and the bank will prepare checks or electronic payments to pay out the loans. This can all take a week or two, with the net result being no actual change in the amount you owe, but now a single repayment, hopefully slightly lower than the sum of what you were paying, improved monthly cash flow, and the chance to start again and get on top of your debt, from a better position with new behaviours.

Slightly lower payments are a good idea as you start off your new repayment regime. It increases the money you have at your disposal each week. Let’s face it, one of the reasons you ended up in debt is because you sometimes did not have enough cash at the time. Give yourself a break and lower your monthly payments, at least for the first six or so months. From then on, you want to steadily increase that payment as your income allows, in order to realise actual debt reduction.

The risks are that the discipline does not continue, and that you go and accumulate another round of unsecured debt. You must avoid this at all cost. Then you might find several years down the track you are tempted, and you are able, to do the same thing again. Spurred on by increasing values of your home, you can take out another line of credit to pay off unsecured debt you have accumulated, and the terrible cycle starts again. This is the exact opposite to debt consolidation. Please do not do this.

Consolidate Debt: Is there a Better Approach To Reducing Debt?

Consolidating your debt into a mortgage is a good way to go, and can help the homeowner out of a particularly bad spot. However, it is not the best way to go. It is my view that the snowball approach is better. The snowball debt reduction technique does not involve consolidating debts, rather focuses on consolidating payments. It keeps the debts, and their monthly statements coming each month as a reminder.

You rank your loans from highest problematic to lowest problematic and pay all at the minimum payment, except for the smallest or the one with the highest interest rate. After you have done your budget, and curbed your spending behaviours, your tackle loan number one aggressively. Add say $100 a week to it, or whatever you can reasonably afford. Once it is paid, you add that payment to loan number two. Once load n two is paid out, you apply the total to loan three. Monthly reminders still come in of your debts, but you also see monthly reminders of the success you are achieving. The achievement of paying off loan number one is significant and will spur you on to keep up the discipline for load two and all subsequent loans.

The snowball approach works, and gives more positive feedback as you go, than consolidating your debt into your mortgage. It is a goal you must hang on to with all your might, to consolidate debt, but you have to go about it in the most effective way.