Footnote Frivolity***, Money Matters

Consolidating debt with the home loan

Three years ago, I wrote a post on switching to a low-interest credit card and or consolidating the credit card debt in the home loan. I said I’d avoid redraw at all costs but never explained the reasons why.

Consolidating personal debt via the home loan seems like good finance. Where else are you going to find credit with such low-interest rates*? However, in spite of the good rates, home loans are mightily expensive. Have you recently looked at your mortgage contract? Over 25 years, that $350K loan will cost you an extra $263 820 in interest**.

Yep, home loans are deceptive. With their low-interest rates, they may seem like the cheapest credit option, but they cost more thanks to a long lending cycle. Add $10k of personal debt to your $350k home loan and you’ll be paying an extra $7538. Compare this to $1881, the interest you’d get from taking out a separate 5-year 7% interest personal loan.

Personal loan versus home loan comparisons
Screenshot of MoneySmart’s Personal Loan Calculator: while the personal-loan debt on the left attracts a higher interest rate, the home-loan debt on the right ends up costing more because it’s repaid at a slower rate.

Debt consolidation via the home loan is also riskier than other types of loans because makes you think you have more money than you do. Say you’ve cleared your credit card balance by rejigging the home loan. Not only have you increased your home loan debt, you now think you’re entitled to use the plastic again. And so the downward spiral continues until the necessary repayments exceed your income and you default on the home loan.

Of course, you can make debt consolidation via the home loan work for you. For instance, you could make additional mortgage repayments that match a personal loan’s repayment schedule. However, this requires self-control. Not everybody has self-control, myself included.

*Actually, I can immediately think of two places: 1) 0% balance transfers when you switch credit cards, and 2) a gentle(wo)men’s agreement with your best mate, since interest on savings is a paltry 2% or something like.

**Based on a 5% interest rate, monthly repayments, and no bank fees. Calculated using MoneySmart’s Mortgage Calculator.

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