Even if you’re financially responsible, you can find yourself in a position with mounting bills from credit cards, car loans, and other expenses.
A debt consolidation mortgage allows Canadian homeowners to help control growing debt. Instead of paying multiple loans with varying interest rates, all of your debt is rolled into one loan with a manageable monthly payment.
Whether you’re familiar with the idea of a debt consolidation mortgage, or completely new to the concept, here’s what you need to know.
Debt Consolidation Mortgages Explained
Also known as cash-out refinancing, a debt consolidation mortgage turns a portion of your home’s equity into cash. The amount available to you depends on the amount of equity in your home.
Home equity is the difference between the value of your property and the amount you owe on your mortgage. As you make mortgage payments every month, the equity in your house grows. Equity also increases if your home increases in value.
Cash-out refinancing is when you take out a new mortgage on your home. This debt consolidation mortgage is worth more than what you currently owe on your house. The difference is the “cash out.”
In most cases, you’ll need at least 20% equity to qualify for a debt consolidation mortgage. Most people need to have owned their home for at least a few years.
How These Loans Have Changed Over the Years
Debt consolidation mortgages are different today than they were a decade ago. Previously, refinancing options were more flexible. It was common to see borrowers cashing out up to 110% of their home’s value.
Today, lenders are far more conservative. As a general rule, you’re required to keep at least 20% equity, which means the maximum loan you can expect is 80% of your home’s total value. The 20% acts as a buffer to protect the real estate and banking industry if the market fluctuates.
What are the Requirements for This Type of Loan?
Obtaining a debt consolidation mortgage is similar to the process used to apply for a standard mortgage. Your credit score plays a key role in determining the amount of the loan. For example, if you want the maximum (80%), you’ll need a credit score of 700.
Generally, for loans of 80% of the value of your home or lower, the requirements are similar (if not the same) as a traditional mortgage.
Should I Get a Debt Consolidation Mortgage?
Your home is likely the biggest financial purchase you’ll make in your life. While that equity can be used for financial support, you want to remain careful about accessing it. Financial experts often refer to it as a “sacred” savings account.
Typically, debt consolidation mortgages are for serious situations. Common scenarios include the following:
- You have significant credit card debt
- You have a sudden, unexpected expense such as a medical emergency
- You want to pay off a large, expected expense such as college tuition
However, you don’t want this type of mortgage for frivolous expenses. For example, it’s generally not a good idea to obtain a debt consolidation mortgage so you can take a vacation or buy a home entertainment system.
Debt Consolidation Mortgages: Pros and Cons
Here’s a breakdown of the benefits and potential pitfalls:
On the plus side, you can access large sums of money. Debt consolidation loans are typically larger than personal loans.
Also, because it’s a secured loan that uses your house as collateral, the loans have low-interest rates. Your monthly payment will typically drop if you use the loan to pay credit card balances or unsecured personal loans.
On the downside, you’re committing to restarting your housing debt. Also, mortgages often require a variety of fairly substantial closing costs. Finally, if you default on the loan, foreclosure is a possibility.
However, a debt consolidation mortgage is often a savvy financial move for many Canadians. It allows you to increase your financial freedom by responsibly tackling any outstanding debts.