Home Buying #Real Estate

Debt Consolidation in Canada | Using Home Equity to Save Interest


In this post, we’ll walk you through everything you need to know about debt consolidation using your home equity. With debt management becoming one of the top reasons why Canadians refinance or take out cash against their equity, it’s important that you know your options inside out. It may seem complicated at first, but we’ll help you understand exactly what debt consolidation is, the different ways you can consolidate your debt using your home equity, and the pros and cons of each solution.


Key Takeaways
  • Equity is the amount of your home that you own outright, that is not covered by a loan. Equity can increase or decrease depending on the market value of your home
  • You can use your home’s equity as security for a number of debt consolidation solutions
  • Debt consolidation is the process of rolling together many debts into one manageable repayment
  • Refinancing, a home equity line of credit (HELOC), or a second mortgage, are all ways to consolidate debts, and they come with different requirements, benefits, and drawbacks

What is debt consolidation?

Debt consolidation is a great way to use the equity in your home to help you pay off your other debts. In simple terms, debt consolidation is where you combine multiple different debts (like credit cards or vehicle payments) into a single loan, using the equity in your property as security. 

You can consolidate your debts into a mortgage – like a second mortgage, or a new mortgage that you get from refinancing your home. Otherwise, you can consolidate them through a home equity loan or home equity line of credit (a HELOC).

If you have a lot of high-interest debt and you want to lower your monthly repayments, debt consolidation may be the right choice for you. By pooling together all of your debt, you can potentially benefit from lower interest rates, a lower monthly payment, and the peace of mind that comes with having all your debt in one place. 

Consolidating options: refinance vs HELOC vs second mortgage

First, let’s look at some of the different ways you can consolidate your debt using your home equity as security.

 

1. Refinancing

Refinancing involves breaking your current mortgage early and replacing it with a new loan. Although refinancing will probably incur a prepayment penalty (since you’re breaking your mortgage before the end of its term), plus some other closing costs, you will now be able to combine your old mortgage and other debts into one single loan (up to 80% of your home’s value).

 

2. HELOC, or home equity line of credit

A HELOC is a revolving line of credit which is secured against your home. With a HELOC, you can borrow up to 80% of the total equity you have in your home. So, let’s say your home is worth $500,000, and you’ve already paid off $100,000. Assuming your home value remains the same, your HELOC would allow you to borrow up to 80% of that ($80,000) in the form of a revolving line of credit – not 80% of the $400,000 balance owing. Consolidating your debts using a HELOC is favored by some due to the flexibility and relatively low interest rate a line of credit provides, since you only pay interest on the balance owed. Plus, you can access your line of credit at any time, up to a predetermined limit. 

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Tip

You can figure out how much equity you’ve built up by taking whatever you owe on your mortgage (and any other loans backed by your home), and subtracting this from the total market value of your home:

Equity = Total market value of home - remaining loan balance

The amount of equity you own depends on the market value of your home. If your home goes up in value, you will have proportionately less loan to pay compared to its value, and you will therefore have more equity in your home.

3. Second mortgage 

Another way to consolidate your debts is to take out a second mortgage, in the form of a home equity loan. This would allow you to pay off all your other debts in one payment, albeit at a slightly higher interest rate than you’d get with a HELOC or via refinancing. However, the higher rate of interest usually found with second mortgages may still give you a lower total monthly repayment than your other debts, since liabilities like credit card debt can have some of the highest interest rates out there. By comparison, a second mortgage may help you lower your monthly repayments.

How consolidating your debt into a mortgage works

Although it might seem complicated at first, consolidating your debt into a mortgage is a relatively straightforward concept. Using the equity available in your home, a debt consolidation mortgage (as it’s sometimes known) lets you roll your high-interest debt together into another loan. Generally, this is done via refinancing. When you refinance to consolidate your other debt, your new mortgage will increase by the amount of non-mortgage debt you’ve rolled into it, plus whatever fees you have to pay for breaking your previous term early. If you’re talking about consolidating your debt into a second mortgage, however, you would not break your previous term. Instead, your lender will provide you with a single lump sum amount, including any debt that you’ve rolled into it for consolidation. Second mortgages typically have much higher interest rates than refinancing, but they may still save you money compared to all the other high-interest debt you want to consolidate.

Upsides and Downsides of Consolidating Debt Into a Mortgage

The benefits of consolidating your debt into a mortgage include:

  • You could save money from reduced interest and lower monthly repayments. Using a mortgage to consolidate debt means you could have a more manageable monthly repayment, since the debt consolidation options available to you are typically geared towards lower interest rate loans or lines of credit.
  • All of your payments will be in one place. This alone can help you manage your money, since you only need to worry about a single repayment each month. Consolidating your debt into one monthly repayment is more manageable than balancing multiple payments for different amounts, potentially to different lenders, with different terms, frequencies, and payment dates.
  • You could improve your credit score. Even a single missed payment among many otherwise successful repayments can cause issues for your credit score. When you’re struggling to make repayments, your credit is likely the first thing to take the hit. By consolidating your debts, you may find repayments more manageable, and this will be reported to the credit agencies who determine your credit score.

 

The drawbacks of consolidating your debt into a mortgage include:

  • You will be in debt for longer. If you use debt consolidation to lower your monthly payments, this is generally achieved by reducing your interest rates and extending the length of time you pay back your loan. By rolling your non-mortgage debts into a mortgage, you’ll have a larger amount to pay back, over a longer period of time.
  • Your equity is used as security and may run out. Your equity is not infinite. Be careful what you use your hard-earned equity for. Although it can be useful to tap into your equity for important things like debt consolidation, it’s not wise to push it to the limit. Eventually, you will run out of equity until you are able to rebuild it. 
  • You could go further into debt. Debt consolidation is intended as a solution for people whose monthly payments are unmanageable for them. Once you’ve consolidated all of your debt, try to be wary of taking on any further high interest debts like credit cards or loans, since these are why you decided to consolidate in the first place. Debt consolidation with a mortgage is intended to help you manage your repayments better, not free up more space for unnecessary borrowing. 

 

How consolidating your debt into a home equity loan works

One final way you can consolidate your debts is a home equity loan. If you don’t want to refinance or get a second mortgage, and perhaps can’t get a HELOC, a home equity loan could be another viable route to reducing your monthly repayments from other debts. A home equity loan can be more accessible than a HELOC, since HELOCs often require that you have a higher amount of equity in your home than a home equity loan. You can also get up to 95% of the equity in the form of a home equity loan from some lenders, although it will have a significantly higher rate of interest than a HELOC, It will also be paid out as a lump sum, as opposed to a revolving line of credit.

A summary of debt consolidation options

We know this is a lot of information to take in, but don’t fret. We’ve broken down the different ways you can use your home’s equity to consolidate your debts in the table below.

 

Debt consolidation solution How much equity will I need? Typical interest rate  Benefits Drawbacks
Refinancing 20% 2.5-3%
  • Lower interest rate  
  • Similar application process to original mortgage 
  • Lump sum payment
  • Breaking mortgage term early 
  • Prepayment penalty 
  • Closing costs
Second Mortgage 5 – 10% 10 – 15%
  • Up to 95% of equity loaned 
  • Lump sum payment
  • Highest interest rate option
HELOC 20 – 25% 2.5 – 3%
  • Revolving line of credit 
  • Flexible 
  • Lower interest than a home equity loan or second mortgage
  • Higher interest than refinancing
Home equity loan  10% 3 – 12%
  • Lump sum payment
  • Higher interest than a HELOC or refinancing

Types of Loans You Can Consolidate

There are many different types of loans that you can consolidate using the equity in your home. Contrary to popular belief, it’s not just credit card debt that fits into this category. All unsecured debt types, plus some secured debts, can be included too. The most common debts Canadians consolidate to save interest are the following:

  • Credit card debts
  • Student loans
  • Vehicle loans
  • Personal lines of credit
  • Unsecured personal loans

Frequently Asked Questions

  • Can I consolidate my debt into a first-time mortgage?

The simple answer is yes – you may be able to consolidate your debts into a first-time mortgage in Canada. Lenders will assess your loan-to-value ratio (LTV) when making a decision. If you pay down at least 20% of your home (an LTV of .8 or below), your lender may let you consolidate your debts into your mortgage.

 

  • Can you combine debt into a mortgage?

As we’ve touched on above, it’s possible to combine your existing debts into a mortgage, as long as your lender feels you have enough equity in your home to use as security for a new loan.

  • Is refinancing your mortgage to consolidate debt a good idea?

Refinancing your mortgage to consolidate your debt may be a good idea if you have a lot of debt and cannot keep up with your monthly repayments. Refinancing may be the best route for you if you have a good amount of equity in your home, and are confident you can secure a lower interest rate by doing so. If the amount in monthly repayments saved by refinancing exceeds the amount you will have to spend in prepayment penalties and closing costs, this may be a viable option for you.

Conclusion

Debt consolidation is not uncommon, and is one of the most popular reasons why Canadians choose to tap into their equity. There are a lot of different ways to use your equity to help you consolidate your debt, and each comes with its own set of pros and cons. Ultimately, your main focus when you choose to consolidate your debts into a mortgage should be to reduce your monthly repayments, with a solution that’s both accessible and manageable. If you need any further advice on how you can use your home equity to save interest and manage your debts, speak to a nesto expert and we’ll help you figure out a solution that fits.

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