Now that the frenzy of refinancing has tapered off, many
mortgage lenders have turned to alternate methods of
marketing their services. Many banks have started pushing
harder to sign up customers for home equity based debt
consolidation loans.
On the surface, debt consolidation loans offer cash-strapped
consumers some relief from high interest rates. Looking
deeper, consumers should be wary of both the pros and cons
of this fast growing practice.
In their simplest forms, debt consolidation loans are
refinance agreements, second mortgages, or home equity
loans. All three loan options allow homeowners to cash out
part of the equity in their homes in order to pay off other
debts. For borrowers who have watched their homes appreciate
in value, a debt consolidation loan can eliminate the burden
of multiple monthly payments without significantly affecting
the amount of their monthly mortgage payment.
On a mathematical level, debt consolidation loans can make
much sense. A home owner who struggles to make the monthly
minimum payments on her 21% interest rate credit cards can
roll those balances into her 7% mortgage. The debt doesn't
go away, but the rate goes down by two thirds. In many
cases, she would only continue to pay about the same amount
per month for her mortgage, freeing up her cash flow for
other uses.
As a side benefit, borrowers can deduct a portion of their
mortgage interest payments from their income taxes each
year. Though not a huge savings, many taxpayers love the
opportunity to look forward to a larger tax return.
The danger lies in the borrower's loss of security on two
levels. First, if a home should suddenly depreciate, a debt
consolidation loan customer could quickly find himself or
herself "upside down" on the loan, owing more than what the
house is worth. As long as that borrower continues to make
payments, they'll survive. But, they will be unable to sell
their home without absorbing a loss. For families who need
to move in order to accept job transfers or pursue
educational opportunities, this can be a devastating blow.
Second, although the lending bank handles paying off the
customer's outstanding debt, the customer must personally
close their old credit accounts. For many customers, the
temptation to keep those accounts open is far too great, and
they find themselves deeper and deeper in debt. In effect,
the debt consolidation improved their cash flow, but
reversed their financial course. Without immediate
intervention, these customers often find themselves on the
road to bankruptcy.
When investigating debt consolidation loans, consider your
long-range plans. If you intend to stay in your current home
for a long time and can handle the potential risk of
depreciation, and if you can exert the willpower to close
out your paid off charge accounts, then a debt consolidation
loan may be a reasonable option for you.
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