Average house prices in Canada increased 12% in 2015. That may be making it difficult for new home buyers to enter the market, but if you already own your own home its likely good news that your home equity just increased. If you are currently trying to pay off credit card debts, you might be wondering if now is the time to take advantage of low mortgage rates and use your home equity to consolidate your credit card debt.
Benefits of consolidating now
If you have built up a large equity over the past couple of years, there are benefits to using a home equity loan for credit card debt:
- Interest Savings. Mortgage rates are always way lower than credit card interest rates, however right now mortgage rates are at all-time lows.
- Fixed and Pre-determined Payment. Transferring higher rate debt into a fixed, 5 year mortgage rate today will not only save you significantly in terms of interest costs it will protect from future interest rate increases. This is especially beneficial if you are consolidating variable rate debt like an unsecured line of credit where your monthly payment will increase in the even rates rise.
- Credit Score Improvement. Moving revolving credit card debt into a term mortgage loan can be beneficial to your credit score by lowering your utilization rate on your credit cards. Of course this assumes that you will not drive those balances up a second time.
Potential risks to a home equity loan
There are however some potential downsides to consolidating unsecured debt, and securing those balances with the equity value in your home.
- Depreciation risk. Economist and market experts can’t seem to agree if we are in a housing bubble. If we are, and the value of your home declines, you may end up with a high ratio mortgage. If this happens at a time when you are set to renew your mortgage, this will increase your mortgage rate substantially on all of your mortgage, not just the amount you consolidated.
- Prepayment penalties. Unsecured revolving credit doesn’t come with a payment term. If your income increases or you come into an unexpected windfall you can always pay revolving credit off early. A mortgage however may have substantial prepayment penalties in the even you want to renegotiate or make extra payments. Check the terms of your mortgage before proceeding.
- Approval time and fees. Factor in the cost of any upfront fees, appraisal costs or other charges that your lender may require you to cover as part of the transaction.
- Default risk. If you default on your credit card debt, your credit score will be impacted and you may start receiving collection calls. However if you default on a mortgage payment, you also risk the loss of your home.
Consolidate with a consumer proposal
Whether or not you should consolidate credit cred debt into your home mortgage will depend on how likely you are to experience any of the above risks. An alternative may be to file a consumer proposal. This would allow you to pay the equity value in your home to your creditors over time, much like a debt consolidation loan, with two very distinct advantages:
- Your payments will be interest free;
- They proposal amount will not be secured against the value of your home.
This can be a viable option when:
- Consolidating your credit card debt will push you into a high ratio mortgage, or
- It will put your home at risk because your new mortgage payment is too high, or
- You owe more than the equity value in your home.
If any of the conditions above are likely, talk to a Licensed Insolvency Trustee before talking out a second mortgage to consolidate your credit card debt. A trustee will help you compare the financial costs and benefits of a consumer proposal to ensure that you protect your home equity for the long term.