Money Mensch: Loans to mortgages can be a big trap
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It feels like a no-brainer: shift expensive credit cards and loans onto a cheap mortgage and, bazinga, you're quids in. Yet while it seems a simple decision, there are mammoth hidden pitfalls that leave some in negative equity or, at worst, cost others their home.
Of course, some do gain greatly so, if you're thinking of moving your cash, here are the six key things you need to know before doing it:
1. Mortgages are secured debts
While secured borrowing sounds better, it's the lender, NOT you, who gets the security. It means if you can't repay, it can take your home – it's the reason why mortgage rates can be much lower than other borrowing.
Therefore by increasing your mortgage to repay credit cards and loans, you effectively convert unsecured debt into secured. So if everything else is equal, it's better to stick with unsecured borrowing.
2. Many can slash borrowing costs without using their mortgage
As it's best to avoid extra secured lending, the real question to ask yourself is 'how does shifting debts to my mortgage compare to just shifting them to cheaper credit card or loan deals?' If the difference isn't big, unsecured wins. Compare your mortgage rate to the following:
● Balance transfer cards
If you've existing credit card debts and a decent credit history, balance-transfer deals let you shift existing debts to a new card at much cheaper rates for a small fee. Often over 20 months 0% is available.
● Do the credit card shuffle
Even if you're refused new credit, you may be able to use your existing debts more efficiently. Call existing card providers to ask if you can shift debts from other cards to them. Though not as cheap, it can be easier to get and protects your credit score.
● Shift existing loans
Cutting the cost of loans is trickier; there are penalties and loan interest rates have increased. If your loan rate is very high and your credit score has improved, it may be possible.
3. It's the interest's cost, not rate, that counts
Which of the following costs less: borrowing £10,000 on an 18% loan or £10,000 on a 5% mortgage? If you're saying "It's blooming obvious", then beware! It's this logic that pushes many to make the wrong decision.
The cost of borrowing isn't just about the rate, it's about how long you borrow for. The longer, the costlier – and most mortgages are over much longer periods than loan or credit cards.
For example, if you borrowed £10,000 at 5% over 25 years, you'd pay £7,500 interest, but at 18% over five years, you'd actually pay less, £5,200 interest.
It pays to do the sums; see www.moneysavingexpert.com/mortgagecalculator
4. Is there room to add debt to your mortgage?
The key mortgage metric is your LTV, loan to value ratio, which refers to the size of your borrowing compared to your home's current value. The lower the LTV, the better mortgage deal you are usually able to get.
You'll usually now need an LTV of under 90% to even get a mortgage. Try to add debts and if your LTV is too high, lenders may refuse.
Even if it's allowed, it could increase the cost of a future mortgage, which may defeat the gain. That's because mortgages usually get cheaper at each of the following barriers: 60%, 75%, 80% and 90% LTV. If adding debt pushes you above a threshold, it could mean next time you want to remortgage, it'll be costlier.
5. Shift debts to a mortgage, keep up current repayments
Don't read this article as if I'm saying 'never shift debts to a mortgage'. For some it saves large amounts of money – my point is just that it isn't a no-brainer.
If you take the plunge, while it's tempting to see it as a way to reduce your total monthly repayments too, be wary, as that could seriously increase the long-term cost.
For example, if you moved a £10,000 typical card debt that was costing you £300 a month onto a £100,000 mortgage and didn't increase the mortgage repayment (£585), you could add over £25,000 to the total interest repaid, because it would take so much longer to repay.
Yet go the other way and keep repaying the same total amount each month (£885) all on your mortgage and in some circumstances you nearly halve the interest – saving £35,000.
6. Only ever do this once
Shifting debts onto your mortgage is psychologically easy. Many feel the problem debts have simply disappeared, as there's no card or loan company chasing.
This risks it becoming a habitual pattern.
I once met a couple who'd inherited a house and then got a mortgage out to clear some of their credit cards. Once that habit started, they kept doing it until they ended up selling the place and coming out with nothing.
So consider putting your debt onto your mortgage as 'spending your house'. If you do it, vow to cut up the credit cards once they're clear and see it as a one-off.