24 Jul


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Many people opt to consolidate their debt for a wide range of financial reasons, and often it is a very good choice. People choose to consolidate their high interest debt into their mortgage in order to reduce the overall interest rate they wind up paying, and create hundreds of extra dollars in disposable income on a monthly basis—money that they can simply save, or put towards other pressing needs.

Consolidating debt is not a novel concept, but it is really only a good option if the person doing the consolidating is not simply looking for a quick fix, and wants the consolidation to work long term. This is true in pretty much all cases, but doubly true for something like a mortgage.

For instance, say that you were able to free up $410 a month by consolidating your debt into your mortgage, and a refinanced mortgage rate was lower than your original one. In many instances, putting your existing debt into your mortgage does come at a significant cost: you’re forced to break your existing mortgage in order for your high interest debt to get amortized into your new mortgage balance, at the newer, lower rate.

You must also factor in that your overall debt is going to go up by a few thousand dollars (the price you are going to incur by breaking your mortgage contract and signing a new one, as well as paying the CMHC premium on your now larger balance), Also importantly, while the rate of interest you are now paying on that formerly high interest debt goes down, you are now going to be making interest payments over a much longer period of time.

The question to ask, then, is what is better: paying high interest for a short amount of time, or less interest over a longer period of time? In order to know that, you have to do the math. This will allow you to figure out what is going to ultimately cost you more money.

Let’s say that you have a $240,000 mortgage at 5.25% interest that is amortized over a 20-year period with monthly mortgage payments of $1,650. You also have $15,000 in additional debt at 19% which you would pay off in three and a half years at $500/month payments.

The total monthly amount that you are spending on servicing your debt is $2,150. The total principal you have paid, therefore, is $260,000. The total interest you have paid would be $155,000, and the total principal plus interest would be $415,000.

After the debt consolidation, those numbers would look like this:

You would now have a $270,000 mortgage at 4.75% still amortized over two decades, with monthly payments that are now at $1,740. Your total monthly payment is now that amount, $1,740. The total principal paid is the aforementioned $270,000 and the total interest paid is $145,000. The total principal plus the interest is $415,000

You will also need to budget an extra, let’s say, $10,000 to cover the fees and whatever surcharges arise from breaking your current mortgage, as well as the new CMHC premiums you are going to have to pay.

The amount of money that this new scheme would save you on a monthly basis would amount to roughly $410.

In the above case, the math makes sense. This is all the more true if you are putting the monthly cash flow to good use, such as investing it in an RRSP or an RESP, or putting the cash into your emergency reserve for when disaster strikes. You do have to factor in a bunch of variables here.

Things like interest rates, amortization, the fees and penalties for breaking your current mortgage contract and signing a new one, these are all important considerations which could make that additional cash flow every month that much smaller. The lesson here is to always do the math and be honest about what the new structure of your debt is actually going to look like and what it will actually cost you.

Another incredibly important thing to keep in mind is that in order for any debt consolidation to make sense, you need to commit to not spending more than you earn. Not having this mindset unfortunately places many people in bigger and bigger financial holes throughout their lives, as they refinance from one bad situation to the next. Discipline, and a hard look at the math is what really decides whether consolidating your debt with a mortgage makes sense.

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