The idea of consolidating personal loans and other debts into your mortgage was the big thing in the early 2000s, with the banks pushing this as the solution to your debt problems. It's worth remembering that banks and other lenders make money out of your debts, so why did the banks seek to push this idea to the masses under the banner of helping you to reduce your debts?
The basic idea is this: the interest rate on mortgages is the lowest of all debt products, so why not move more expensive debts (such as credit card balances and personal loans) into the loan with the much lower interest rate? While it might sound like the lender is being a knight in shining armour and coming to save you, realise that you will be increasing your long-term debt, increasing your total interest payments on your mortgage, and increasing the overall share of lending taken by your mortgage provider.
We've already looked at debt consolidation on the Common Mistakes page but the consolidation story is not necessarily a bad one - it does, however, take great self-control on your part to really make it work for you. Let's look at an example to illustrate the good and the bad of this approach to reducing your debts. Suppose you have a $200,000 mortgage against a property worth $300,000 so you have plenty of equity against which the bank will be happy to increase your mortgage for the purposes of debt consolidation. We'll assume your mortgage interest rate is 7% and the mortgage has 25 years to run. You are about to purchase a car for $30,000 and the dealer has offered you a car loan at a rate of 11%, repayable over 5 years. Should you roll this debt into your mortgage rather than taking out the more expensive car loan? It sounds obvious that you should, since your mortgage interest rate is much lower...
Your current monthly repayment on the mortgage is about $1400 and the total interest payable over the loan term is $224,000. The car loan repayments would be $650 with a total interest amount of just over $9,000 over the five year term. Now, suppose you put the $30,000 cost of the car onto the mortgage instead so the mortgage increases to $230,000 - the minimum monthly repayment only increases slightly to $1625, so it 'feels' like you're $400 or so better off by using this method ($650 for the car loan option against an increase in your mortgage payment of only $225 or so) - but remember the mortgage is over a much longer term and, as a result, the total interest payable increases astonishingly, to $258,000 - an increase in interest of more than the cost of the car!
The trap is in not paying additional repayments on the mortgage to cover the additional $30,000 car cost, lured by the minor increase in the mortgage monthly minimum repayment amount. If you can pay an additional say, $600 per month off the mortgage for five years then you will have made the most of the consolidation by actually only paying 7% interest on the car-related portion of the loan. Needless to say, most people do not do this and it is in this way that the banks pocket massive amounts of additional interest for consolidated loan amounts. The worst part of this is that the additional interest is likely to be payable against depreciating assets such as cars, general consumables (from say a credit card balance), etc.
The following calculator allows you to work out whether to consolidate or not and warns of the extra interest you may end up paying if you do consolidate but don't increase your monthly payments to clear the extra debt you've rolled into your mortgage. Enter your existing mortgage details then enter in each addtional loan you're thinking of rolling into the mortgage. The calculator will then show you the interest you will pay if you leave the loans separate and compares it to the total interest payable on your mortgage should you choose to consolidate.
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