Debt Consolidation – Good or Bad?

It seems that everywhere you look these days you can find ads trying to entice people to consolidate debts.

The usual catch-cry goes something like this: “Put all your personal debt (car loans, credit cards etc) into the home mortgage AND cut your repayments in half!”

Let me tell you – those ads are RIGHT. You really could cut your monthly repayments in half. Imagine how much extra money you’re going to have in your pocket each month if you just called a consolidation company or lender nextdoorloansusa.com and let them fix it all up. What those companies DON’T tell you is that when you consolidate you could end up paying WAY more money in the long run for something you probably don’t even own any more.

How They Do It

Let’s look at the sales-method calculations used by consolidation companies and see how they really CAN halve your monthly repayments.

Example:
Home Mortgage: $120,000 at 7.5% over 30 years = $839.06 per month
Car Loan: $15,000 at 10.25% over 5 years = $320.55 per month
Credit Card: $5,000 limit at 18.25% = $80 per month (interest only plus small nominal payment)

Your total monthly expense for the example above is: $1,239.61 per month.

Now, your consolidation company would tell you that if you put your personal debts into your home mortgage and refinanced them, you could cut your monthly payments dramatically!

If you refinanced your home mortgage to include your personal debts, then your NEW loan amount would be $138,000 ($120,000 + $12,000 + $5,000 + $1,000 closing costs = $138,000)

New repayments for a loan of $138,000 at 6.5% over 30 years = $872.25 per month
That’s a potential saving of $367.36 every month. Wow! An extra $367 in your pocket every month. Imagine what you could do with that! No wonder those debt consolidation ads are everywhere you look.

Okay – we didn’t cut your repayments in half, but you can be sure that if I’d used bigger numbers and higher interest rates, I could have worked out a way to show you a GREAT sales pitch for consolidating your debts.

How We See It

The reality of the situation is a little different…

You see, if you continued to pay your $15,000 car loan at $320.55 per month for 5 years, then at the end of 5 years, you would own that car.

Paying $320.55 per month x 60 months (5 years) = You would have paid $19,233 for that car over 5 years.

But if you consolidate that $15,000 into your home mortgage, it will take you up to 30 years to pay off the same car. Let’s see what happens if I work out the cost now…

$15,000 at 6.5% over 30 years = $94.81 per month x 360 months (30 years) = $34,131.60 for the same car!
Would you pay $34,131.60 for a car you know should only have cost $15,000? I know I wouldn’t!

I’m guessing that in 30 years time you won’t even have the same car any more, so you’ll probably be paying off a different car (or two) by then AS WELL.

The same principle applies to your credit card. Will you even remember what you bought for $5,000 in 30 years time? Not likely?

Before you consolidate your debts onto your home mortgage, ask yourself if you couldn’t perhaps budget your current income just a little differently to avoid having to get into a situation that just keeps you in debt even longer than you already will be!