There are two reasons why remortgaging has become popular in recent years. On one hand, consumer debts are high, with individuals taking on tons of credit card debt in order to finance their lifestyles. On the other hand, interest rates on mortgages have remained relatively low, making it increasingly attractive to think about getting a new mortgage. If you can find a lender willing to offer you a lower rate or favorable terms, you stand to save a lot of money over time.
Another reason that people seek remortgaging is debt consolidation. Remortgaging can seem like a relatively cheap and easy way to borrow extra money usable to pay off your other debts. Essentially, you’re dipping into your home’s equity, hoping that your home’s value will increase enough to match the increased borrowing. This seems like an obvious solution to debt problems.
The truth is that it might not be. While remortgaging can be a legitimate financial move, if done wrong, it can make your debt even worse. Here’s what you should watch out for if you’re thinking about remortgaging to consolidate your debts.
You could be paying off your debts for a long time
Mortgages, by design, take a long time to pay off. They finance what is likely your biggest investment: your home. They are not there to help you pay off consumer debts such as credit card debt.
This longer repayment period isn’t just potentially inconvenient, it can lead to you paying much more for your debts overall.
The longer your debt repayment lasts for, the more time your debts will have to accrue interest. This point is often lost on people who are only interested in thinking short term. They might see that their monthly debt payments after remortgaging and consolidating their debts are lower than they would be otherwise, so they assume that they’re saving money. Unfortunately, while they might be saving money up front, they often end up paying a whole lot more to their lender over time due to the added interest.
Interest rates and payments aren’t always predictable
Interest rates for mortgages have held at record lows for some time. While they aren’t quite as low as they were even a year ago, they’re not likely to rise much anytime soon.
The above chart from Freddie Mac (the Federal Home Loan Mortgage Corporation) shows how mortgage rates have changed in the past year alone. Rates hit record lows in the summer of 2016 but rocketed up later in the year, settling at between 3.14% and 4.05%, on average, depending on the type of mortgage.
The point isn’t that current mortgage rates are especially favorable or unfavorable for remortgaging and debt consolidation, it’s that mortgage rates are subject to change, especially if your lender hasn’t fixed your rate. There’s just no way to predict where your rates will land in the future.
Despite this potential instability, most people who consider remortgaging make the assumption that mortgage interest rates will remain as low as they are into perpetuity. That’s not the case, and if rates do skyrocket, you’ll end up paying much more on your debt than you initially bargained for.
You make it likely that you’ll go “upside-down” on your loan, exposing yourself to negative equity
If you’ve researched home loans and remortgaging, especially in the wake of the 2008 financial crisis, then you’ve probably heard of people who are “upside-down” or “underwater” on their mortgages. What does that actually mean?
“Upside-down” is a nickname for negative equity. In relation to your mortgage and your home, negative equity occurs when the total amount of your home loan is greater than the market value of your home. If your mortgage is for $200,000 but the market value of your home is only $150,000, then those numbers are “upside-down.” You have negative equity in your home.
Of course, no one wants negative equity, and both lenders and homeowners try to avoid it whenever they can. When individuals are shopping for a new home and find one they like, they generally don’t get a mortgage loan that covers 100% of the home’s cost. Usually, lenders will offer a mortgage that is closer to 80% since this helps manage their risk in lending.
However, negative equity happens often when it comes to homes and mortgages. If the housing market shifts and your home’s value drops, or it was artificially inflated in the first place, then you can find yourself upside-down on your mortgage quickly.
There’s a lot you can do to deal with this situation if it happens to you, but we won’t cover that here. Rather, we want to make the point that remortgaging to consolidate your debts can make this unfortunate occurrence even more likely.
When you remortgage for debt consolidation, you ask the lender to increase the total amount of your mortgage so you can use the extra funds to pay down your debts. They’re increasing the amount of the loan, but you’re not increasing the value of your home. If the increased loan doesn’t push your mortgage upside-down on its own, it still gets you closer to that possibility, opening you up to increased risk.
Why should you care about negative equity and upside-down mortgages? Because you might want to sell your home at some point in the future (according to FiveThirtyEight, the average American moves 11.4 times in his or her lifetime).
If you’re upside-down on your mortgage, you can end up financially trapped in your home. If you paid $200,000 for your home and can only get $150,000 for it on the market, you’re going to be much less likely to move and take that loss, no matter how much you want to get into a new home.
You free up a ton of credit at once, which can lead you into temptation
Anyone with a rudimentary grasp of finance and the English language knows that irresponsible use of credit is, well, irresponsible. Using credit to finance unnecessary expenses, even if those expenses are relatively minor on their own, is the gateway to a life governed by debt and financial instability.
We all know that, but we still do it. According to ValuePenguin, 38.1% of all households in the United States carry some kind of credit card debt month-to-month. The average amount of debt for those balance-carrying households is $16,048, and a great deal of them did not get in that position by spending responsibly and budgeting wisely.
The point is that it’s not always easy to resist the temptation to spend using credit. Even though we know that we shouldn’t, we can easily give in to the urge to whip out our credit cards and buy what we want to buy, “just this once.” All of these exceptions add up. All of a sudden, we’re drowning in debt without much to show for it.
Of course, there are situations where it’s near impossible to get by without borrowing money or resorting to the use of credit. Medical emergencies, unexpected car repairs, and other dire circumstances can come out of nowhere and put a huge strain on our finances. However, these situations are not the only reason people run up their credit cards and go into debt.
Let’s apply this insight, then, to remortgaging in order to consolidate debt. Imagine that you’ve decided to go ahead and remortgage, borrowing enough money to pay off all your credit cards. Many of these cards were at or near their limits before you paid them off, and all of a sudden, you have freed up a pile of credit. You have a new lease on life and a newfound sense of financial destiny.
What’s your first impulse? If you’re like most people, it’s to reward yourself, maybe by using just a bit of that newly freed-up credit to finance an expensive purchase or experience that you otherwise wouldn’t be able to afford.
Now that you’ve consolidated your debt payments, you find that you have more money left over at the end of the month. Do you save it, or do you combine it with the newly available credit to finance a lifestyle that you couldn’t otherwise afford?
Some people, of course, can handle the responsibility that comes with freeing up a ton of credit at once. However, it can definitely be a dangerous temptation, especially if you have a history of overusing credit in the first place.
Remortgaging to pay off your debts treats the symptoms of indebtedness, not the causes
This point is similar to the former one, but different (and important) enough to pull it out for discussion on its own.
What’s the reason that you got into so much debt in the first place? Was it because you wanted to treat yourself to the finer things in life, but you couldn’t stretch your paycheck enough to make it work? Was it because you couldn’t say “no” to a night out with your friends, even if your bank account was nearing zero? Were you living outside of your means and refused to admit it?
Maybe the reason you fell into debt was less personal. Perhaps you had to pay for a trip to the emergency room, for instance, and the ambulance ride alone drained your savings. You had no choice but to lean on credit in your time of need.
If you’re considering remortgaging to pay off your debt (or really, any form of debt consolidation), you need to have a good handle on exactly why you got into debt in the first place. That’s because remortgaging does nothing to alleviate the causes of your debt; it just helps to make the symptoms a little bit more bearable.
Sure, remortgaging might help you to consolidate payments so that they’re easier to keep track of. It might help you pay less each month on your debt. It might give you the breathing room you need financially to not constantly be in a panic about your income. However, these outcomes, great as they are, are not the cure for your debt. They just empower you to figure your financial situation out a little quicker.
If you fell into debt because you were irresponsible and impulsive and couldn’t say no to yourself, then you need to learn a little bit of self-control. Set a budget and stick to it, keeping track of all of your income and expenses every month and saving every penny that you possibly can to give yourself a financial cushion to avoid spending on credit.
If you fell into debt because of a situation outside of your control, you can still do plenty to ensure that it doesn’t happen again. Dedicate yourself to saving as much money as possible each month so that you have a robust emergency fund at your disposal in the event that something goes wrong. Even putting $500 to $1,000 in a savings account can be the difference between paying a bill yourself and opening up a credit card just to get by.
If you don’t confront the behaviors that led to you falling into debt, though, you’re likely to fall back into the same habits not long after you’ve remortgaged to consolidate your debt. The result: you’ll run up the same amount of debt within a couple of years, digging an even deeper hole than before.