The Best Way To Consolidate Debt
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.
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. While using a Home Equity Line of Credit (HELOC) is not the best way to consolidate debt, it ranks quite high since it offers substantial flexibility. In particular, repaid and unused credit under a HELOC can be accessed by the borrower. As well, rates on a HELOC are almost always prime-based and with prime as low as it has been, it has certainly been advantageous for borrowers to use this option. Another key benefit to a HELOC is that the minimum monthly payments are quite low, allowing borrowers to improve their cash flow while simultaneously enjoying the lowest rates available (today).
2. Refinancing a First Mortgage. This would be the best way to consolidate debt in almost every instance. Although breaking the term on an existing mortgage may involve fees or penalties, borrowers need to consider the overall picture. Namely, how much they will save in annual interest costs and how much they can improve their monthly cash flow by consolidating all debt under one umbrella. Since First Mortgage rates are clearly far below existing consumer debt rates, borrowers benefit in terms of reducing their debt costs. As well, since mortgages can be amortized over extended periods of time, they most often benefit in terms of cash flow improvement as well. The largest drawback to refinancing a mortgage is that is eats up your available home equity rather quickly, which can result in stressful, sleepless nights when real estate prices plummet as they did in 2007 and last year.
3. Obtaining a Second Mortgage. Second mortgages often come with rates that are lower unsecured credit rates. Second mortgages can sometimes have low monthly payments (often interest-only). However, it is unlikely that a Second Mortgage will ever be the best way to consolidate debt for any borrower. In cases where equity is slim or the borrower’s income cannot be properly substantiated, or where the borrower cannot obtain a refinance or HELOC through their original lender, then a Second Mortgage becomes a viable option. While the savings in terms or interest costs and monthly cash expenses might be minimal, they often better than any of the unsecured alternatives.
People who are looking for the best way to consolidate debt need to review their secured options first. Secured rates and terms will always be better than unsecured alternatives on two fronts. One, the rates will be significantly lower. Two, secured repayment terms are normally lower on account of longer amortization periods and lower rates. No matter what option borrowers choose, using the equity in a home is always the best way to consolidate debt over the long term.
