There are two main considerations when looking for the best way to consolidate debt. Most financial services professionals will offer the solution that makes the most sense for them, whereas the borrower (you) need to determine whether it makes financially in terms of how much you save in interest and how much you can increase your monthly cash flow. Both objectives are seldom met and as a result borrowers need to prioritize how they repay their debt, even if it not always the best way to consolidate debt. The options presented here allow borrower to achieve both — reduced interest costs and improved cash flow. Other alternatives will be reviewed elsewhere.
Without question, the best way to consolidate debt involves using home equity. Provided the borrower has enough equity, he or she can secure a Home Equity Line of Credit, can refinance an existing First Mortgage, or can obtain a second mortgage. Since rates given on credit that is secured are by far much more attractive than unsecured rates, using home equity is clearly the best way to consolidate debt. These three options will be discussed in greater detail here.
1. Home Equity Line of Credit. Surely, using a Home Equity Line of Credit is not the best way to consolidate debt, but it ranks highly. The reason is that a HELOC offers great flexibility to borrowers since any unused or repaid credit can be accessed at a later date. More importantly, rates are usually extremely favorable since they are variable and often based on prime. This meets the lower-interest-cost requirement! Additionally, monthly payments to a HELOC are normally very low, some as low as “interest only.” However, the flip-side to an interest-only payment is that it does not improve your overall finances if that is all the borrower can afford to make. In order to improve net worth, that debt needs to be repaid.
2. Refinancing a First Mortgage. This is clearly the best way to consolidate debt in almost every situation. Although there can potentially be penalties and fees to break an existing mortgage term, borrowers should evaluate the savings over their existing debt situation and consider how much they will save over the life of the debt. This can be measured as simply as finding the difference between interest rates and can also be measured by reviewing the monthly cash flow savings. With First Mortgage rates quite low, especially now, borrowers will not only benefit from exceptionally low credit rates, but from a much lower, single monthly payment. As the best way to consolidate debt, the First Mortgage option does have a fairly large drawback; the consolidated debt erodes the equity previously available in the home.
3. Getting a Second Mortgage. With Second Mortgages, borrowers are likely to pay steeper rates than First Mortgages and Home Equity Lines of Credit. Despite this, Second Mortgages quite often come with preferred repayment terms, such as interest only. This means that the borrower can cut back on their monthly payment obligations rather substantially, even though they are not making much progress financially. With a Second Mortgage, borrowers are usually left with no other option; they cannot qualify for a HELOC or a refinance on their First Mortgage. Although interest savings are minimal and Second Mortgages are indeed the least favorable of the debt consolidation methods examined here, they do provide preferred rates and terms compared to unsecured options.
Borrowers seeking the best way to consolidate debt should always consider their “secured” options first. These will help borrowers become financially better off on two fronts. The first is in total interest costs paid. The Second is in an improvement to cash flow. Regardless of which options makes the most sense for any given borrower, using the equity in the home is definitely the best way to consolidate debt.
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Tags: consolidate debt, Debt Consolidation, debt repayment, HELOC, Mortgage, mortgage refinance, personal finance management, personal mortgage, second mortgage