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The Best Way To Consolidate Debt

Todays Date: December 15, 2018

When people are looking for the best way to consolidate debt, there are several options their financial services professional can offer. However, there are only a few that make the most sense in terms of reducing interest costs and simultaneously improving cash flow, both of which are discussed here. Unfortunately, most borrowers cannot achieve both of these objectives and must therefore prioritize their financial objectives, even if it is not necessarily the best way to consolidate debt. We have discussed and will discuss these options elsewhere.

Arguably the best way to consolidate debt is to incorporate debt into your mortgage. This can mean using existing home equity to secure a Home Equity Line of Credit, refinancing your first mortgage, or even obtaining a second mortgage. The reason this is the best has to do with the fact that secured rates (rates given on loans that are secured by equity in real property) are much lower than unsecured rates. As such, you will quite likely pay much less interest on a year-over-year basis than you pay on your existing debts. We will review these options in greater detail:

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 who want to find the best way to consolidate debt are always wise to use the equity in their home as a way to secure financing. This tactic is optimal for two reasons. The first is that secured lending comes at a lower cost compared to unsecured lending, thereby saving the borrowers in terms of total cost of borrowing. The second is that payments are typically lower on secured credit because the amortizations can be stretched farther and the lower rates allow for lower payments, resulting in greater monthly cash flow. In the end, the borrower should always consider secured options as the best way to consolidate debt over the long haul given the pure financial benefits.

With over 10 years of mortgage-specific experience, Julie Hammond has been helping thousands of borrowers save money with their debt. She is regular contributor to the Nevada Mortgage website, which provides visitors with details specific to Nevada’s Mortgage industry. Please visit the site at Best Mortgage Nevada (dot) com.

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