The Risks of Consolidating Debts when Refinancing Your Home

Consolidating debts with your home mortgage can help reduce your overall cost of financing. However, the process is not risk free. Whenever you modify loans, especially loans as large as a mortgage, there are drawbacks that come along with the reduced expense of the loan. These drawbacks can outweigh the benefits.

Consolidation Process

Consolidating loans typically involves four primary steps. The first is determining a lump sum settlement on existing loans. This settlement should be less than you would owe if you paid off the loan over time. Next, you will have to find a new loan large enough to cover the settlements of all of your existing debt. This new loan will become the only debt you have, hence the consolidation of debt. Finally, this new loan should be achieved at a lower average interest rate than you are currently paying on loans.

Consolidating to a higher interest rate will only cost you money over time. This should be avoided, even when it is tempting in order to reduce the burden of paying multiple bills. You should aim to have one monthly payment at the end of a consolidation process that is lower than the sum of existing payments. 

Loan Modifications and Credit

Anytime you modify a loan, you will see the modification hit your credit report. Loan modification harms the lender. When a loan is modified, the lender makes less than it originally planned on the loan. This decrease in revenues to a lender will cause the lender to report the activity to credit bureaus. The drop in credit may not seem like a large problem. However, if you are going to seek additional loans in the next few years, having the recent consolidation and refinance on your report will raise the cost of the new loans. The result may be an inability to get loans, and the loans you do get will be significantly more expensive due to higher interest rates. All told, the consolidation can end up costing you money in the long run rather than saving you money. 

Aggregated Risk of Default

You are combining all of your debts into one new loan with consolidation steps. This means your mortgage is lumped together with your student loans, personal loans and even your credit card debt. When your debts are distributed to separate lenders, you can default on one without defaulting on the others. For example, you can default on the financing for your computer, but your mortgage will stay in good standing. When you consolidate, you are risking all of your assets in one single loan. Since the monthly payment on this loan is large, the chance you will not be able to make the payment increases. You cannot choose to pay only the portion of the payment that applies to your mortgage. Instead, you have to make the payment in full each month. If you are short, even by a small amount, you can have your home foreclosed on. There is an aggregated risk of defaulting on your loan when you consolidate.