The Financial Regulator does a pretty good job of keeping its finger on the financial pulse of the nation as it highlights the dangers of overspending on credit cards or how to avoid an insurance rip-off.
Its latest concern, and a timely one, is the thorny issue of debt consolidation.
In this column, the big kudos go to people who aim to pay off their debts sooner, not later – by accelerating mortgage payments, for example, a sure fire, guaranteed way to reduce the numbers of years you will spend paying a home loan and the total interest cost of your purchase.
For example, the recent first time buyer of a house with a €300,000 mortgage, paying six per cent interest over 25 years will have to pay their lender €1,904 a month and total interest of €271,159 as well as the original €300,000.
If they could possibly afford to pay another €100 a month, however, their repayment time drops to 22 years and four months and their total interest bill falls by nearly €33,500.
Unfortunately, times are getting even tougher for people with new mortgages in particular, or for anyone who has lost their job (even temporarily) or who has overextended themselves with other debts, like personal loans and credit cards.
The owner of an outsize mortgage acquired in the last few years is going to have a tough time finding the kind of debt consolidation finance the Regulator is warning against – at least from conventional lenders.
These days, you need three things to get this kind of credit: a near perfect credit record, a very solid job and plenty of equity already built up in your home.
If you tick all of these boxes you need to go into the new credit arrangement with all your little grey cells in full working order; no more signing on the dotted line without taking out a calculator and working out both the short and long term consequences of pooling all your debt.
Most of all, warns the Regulator, harking on a downside that has already happened to hundreds of thousands of Americans who took out consolidation loans, ‘Understand the risk’.
Because the new larger loan is secured on your home, if you fail to keep up with your repayments, there is a risk that you could lose your home.”
So what exactly is a consolidation loan? If you’re a fan of a tabloid newspaper or afternoon telly you couldn’t miss the headline grabbing adverts that extol the attractions for homeowners of pooling all your debts and so on.
Unfortunately, many of those ‘red top’ advertisers charge sub-prime, i.e. much higher, interest rates than conventional bank loans.
On its website, www.itsaboutmoney.ie, the Regulator gives a rather out of date example (it hasn’t updated the 3.6 per cent mortgage interest rate it is using) of a debt consolidation, but it’s still useful in showing just what happens to the cost of borrowing when you are approved for such a transaction.
The Regulator’s example is someone with a €100,000, 20-year outstanding mortgage who also has an additional €58,000 worth of home improvement, car and personal loans that differ in both interest rates and terms of mostly five or seven years.
By arranging a new €158,000 consolidation mortgage over 20 years, the monthly repayment is reduced by over €600 a month from €1,572 to just €920. (This example uses a 3.6 per cent mortgage rate and a 4.1 per cent car loan rate, neither of which are still available.)
The downside is that the total cost of credit has gone up by about €12,000, from just under €51,000 to nearly €63,000 because the short term loans – the car, home improvement and personal loans – have been refinanced over a much longer term of 20 years.
This wasn’t such a problem when house prices were rising at 10 or 12 per cent or even higher percentage rates every year between 1996 and 2006.
But if you had bought a 25 or 30 year, €300,000 mortgage in the last two years in particular, your €330,000 house (the extra €30,000 represents a 10 per cent down payment) might now only be worth €280,500 (a 15 per cent drop).
Even if you could convince your bank to add the consolidated value of your other borrowings to your mortgage – and this is a big ‘if’ – you are now going to be paying about twice the original 2005-06 mortgage interest rate.
The other big danger about consolidation loans is that too many people fail to grasp that the lower monthly repayment is a sort of ‘get out of jail’ card and that you mustn’t start taking out any new debts until the bulk of this one is paid off.
Finally, if you must go for a consolidated loan, follow the Regulator’s last piece of advice and consider a consolidated personal loan, rather than a mortgage-based one – you will have to pay if off sooner.
The same effect can be achieved if you do take out a mortgage consolidated loan if you have the discipline to accelerate your monthly mortgage payment in an attempt to still pay off the personal loans sooner.