About Debt Consolidation

Get the facts before you sign anything.  Consolidating your debts can ease your cash flow and lower your monthly payments, but you still need to pay off the loans.  Read on to make sure you get a fair interest rate and aren’t locked into something like a pre-payment penalty.

Q: What exactly is debt consolidation?
A: In its simplest form, debt consolidation involves out a new loan to pay off a bunch of others that usually have higher interest rates. For our purposes, the debt consolidation options available to you here are simply refinancing your current mortgage to add the additional debt, cash-out refinancing, a home equity loan and a home equity line of credit (HELOC).

Q: When is debt consolidation a good option?
A: Debt consolidation is a good option when you have a lot of high interest debt, such as credit cards, student loans or car loans. By combining all this debt together into a single payment, you can potentially save a lot of money in both interest and principal.

Q: Are debt consolidation loans tax deductible?
A: Yes. When rolling your debt into a new mortgage, or using a cash-out refinance, home equity loan or home equity line of credit (HELOC) to consolidate debt, the interest accrued can be deducted from your year-end taxes.  As always, consult with your tax advisor on your individual situation.

Q: If things get better can I pay off a debt consolidation loan early?
A: Of course. But there are a few things you must keep in mind. First, if you agree to a prepayment penalty, then you would have to pay an extra charge on top of the remaining balance. We highly advise that you never agree to one of these just in case you do become able to pay off the loan before its term expires. Secondly, if you decide to roll your debt and your existing mortgage into a new loan, then you would need to make separate additional principal payment(s) each month to pay off the debt. Obviously, it’s easy to do, but still helpful to know about beforehand.

Q: My monthly payment would be lower so why shouldn’t I consolidate?
A: It all depends on which is more important (or pressing): your short or long term goal. If you absolutely must reduce your debt right now and a debt consolidation allows you to do it, it’s a no-brainer. However, if this isn’t an issue, the situation becomes somewhat more complicated. Take a hard look at your current debt. How long would it take to pay off the debt in full? Then look at the terms of the debt consolidation loan. In some cases, lower payments result from a significantly reduced interest rate, in other cases the reduced payment can come entirely from extending the payoff time to as long as 30 years. Therefore, it’s quite possible (and actually probable) that you’ll spend more in the long run by consolidating your debt. This is because you’ll be paying interest on the balance for a longer period of time. So, you see, the best answer all hinges on what you need and when you need it.

Q: By consolidating my debts, will all my cash issues go away?
A: Refinancing with a debt consolidation is a great way to get out from under an unmanageable mountain of debt. However, to remain in the clear you must closely examine how you got into the cash crunch in the first place. If you don’t, you’re more than likely to fall in line with the old saying “those who do not study history are doomed to repeat it.” If you learn from it and live wisely moving forward, you’ll find your life a lot less stressful and a lot more financially stable.

Q: Can consolidating debt through a new, refinanced mortgage, cash-out refinance, home equity loan or home equity line of credit (HELOC) help me cut my monthly expenses?
A: Definitely. When these types of loans carry a low enough interest rate and/or offer longer terms compared to your current debt(s), your payments can be significantly reduced. Plus, making one monthly payment is much easier than making a bunch of smaller ones.  Just don’t go back into debt once your credit cards are paid off!

Debt Consolidation Interest Rates

Q: What is APR?
A: The acronym stands for Annual Percentage Rate (APR). Basically, the APR shows the cost of the loan, expressed as an interest rate. Because there are always other finance charges in addition to the note rate (the interest rate base on which payments are calculated), the APR is almost always higher than the note rate. The APR is one of the items required to be disclosed in the Truth-in-Lending form.

Q: Why is the APR different from the interest rate for which I applied?
A: As we just discussed in the previous answer, the APR is computed from the amount financed and based on what your proposed payments will be on the actual loan amount. For example, on a $50,000 loan with $2,000 prepaid finance charges, a 30 year term and a fixed interest rate of 7%, the payments would be $332.65 (principal and interest). Since the APR is based on the amount financed ($48,000), while the payment is based on the actual loan amount ($50,000), the APR of 7.4095% is higher than the interest rate.

Q: How do I find the lowest rates?
A: Use the mortgage interest rate tables on RateNerd.com to select a few lenders to speak to, and then negotiate hard! And make sure you know what your credit report says before you speak with a lender.

Q: How often do interest rates change?

A: Interest rates can sometimes change several times a day. This is because they’re dependent on a bunch of different  variables, such as the bond market, the type of loan you’re seeking, your credit profile, the amount you plan to mortgage, and others so it’s impossible to know if or when they will change. Read our article on Understanding Rate Fluctuations for even more information.

Q: How do I best compare the debt consolidation offers from different lenders?

A: Three words: Good Faith Estimate (GFE). This standard form will allow you to accurately and fairly compare rates and fees. This gives you the chance to uncover any hidden fees and the true differences between loans. You will also want to look at the APR on the Truth-in-Lending Statement. The general rule of thumb here is that the lower the APR, the less cost associated with the loan.

Q: What is a Good Faith Estimate (GFE)?
A: A Good Faith Estimate (GFE) is a preliminary estimate of the closing costs and fees for your mortgage. When comparing lenders’ offers, make sure that you review this form along with the Truth-In-Lending Statement from each lender.

Q: What is a Truth-In-Lending (TIL) Statement?
A: A TIL is used in connection with the GFE. A TIL gives you the total cost of a mortgage with the closing costs and fees included. A TIL will allow you to determine if a higher rate with low fees is better for you than a lower rate and higher fees, and vice versa.

Q: What is PMI?
A: Private Mortgage Insurance, or PMI, is insurance from a private company that is required when the borrower does not have a minimum 20% down payment for a purchase or 20% equity in the home on a general or debt consolidation refinance. PMI is an insurance that you, pay for to protect the bank in case you default on your loan.

Q: What is PITI?
A: It stands for principal, interest, taxes (property taxes) and insurance. In essence, it’s the cost of living in your particular home. In some cases, PITI can also include private mortgage insurance and homeowners/condo association fees.

Qualifying for a Debt Consolidation Loan

Q: What information is required to apply for a debt consolidation loan?

A: We will need your current residence, employment history for the past two years and a rundown of your current income and assets. From this information, as well as the potential loan programs open to you, we can then let you know the amount and type of additional information we may need in order to keep the process rolling. Take a look at our article on Getting Your Debt Consolidation Started for an even deeper explanation of possible requirements.

Q: What is DTI?
A: This stands for debt-to-income ratio. This pretty much will decide how much of a loan you can afford. You get this number by dividing your total monthly debts by your total monthly income.

Q: What is a loan-to-value (LTV) ratio?
A: LTV is the size of your proposed loan in proportion to the value of your home. For example, if you are buying a home for $200,000, and you make a down payment of $20,000, then your loan amount would be $180,000. Your LTV would be 90% (the loan is 90% of the value). It is important to know that lenders will always use the lesser of the appraised value or the purchase price for the value. If you refinance, then the appraised value is used.

Q: What is a credit report?

A: A credit report contains information on how you pay your bills, where you live and work, and any information that is on public record, such as bankruptcy, judgments, tax liens and lawsuits. Your permission is required before a copy of your credit report can be ordered. In order to obtain the report, you will need to supply your name, address and social security number. Please keep in mind that your credit scores may drop if you allow too many people run your credit.

Q: What are credit scores?

A: Essentially, your credit scores are an estimation of your creditworthiness. These appear on your credit report with FICO being the most well-known rating. Your FICO score is computed by the credit reporting agencies based on factors such as the amount of current and past credit, payment history, late payments, and others.

Q: Should I be worried about past credit issues on my credit report?

A: On average, unfavorable credit issues, such as late payments and charge offs, remain on your credit report for seven years. However, extreme events like bankruptcies – 10 years – and lawsuits – indefinitely – can remain for much longer.  If you have several of these and your score is below 650, you should consider using a credit repair firm to see what can be done.

Q: Does bad credit automatically disqualify me from a debt consolidation loan?
A: Nope. A loan program can be obtained by people with all kinds of credit. Obviously, the rates will increase as credit score decreases, but there’s still a potential loan program out there for you. However, with a lower credit score you may also be limited to a few less mortgage loan programs than you would with excellent credit. The good news is that mitigating factors such as: a lot of money in the bank; funded 401k’s; investments; long-time employment; low loan-to-value (LTV) and debt-to-income (DTI) ratios; and lower terms (15 year instead of a 30 year) may help to compensate somewhat for a lower credit score and qualify you for a better rate.

Closing on your Debt Consolidation Loan

Q: How long will it take to process and close my loan?
A: Though this timeframe varies from loan to loan, and by lender.   The Mortgage Rate Tables on RateNerd.com can help you find a reputable lender with low rates, and with high customer service levels to keep you up to date on the process all along the way.

Q: Can I roll my closing costs into my debt consolidation loan?
A: Yes, most of the time you can finance all your closing costs just as long as there is enough equity in your home. Just remember that by doing so your balance will increase, which may also drive your rate up as well.

Q: What does my mortgage payment include?
A: For most homeowners, your new monthly mortgage payment will include principal (actual repayment of the amount borrowed), interest (additional payment to the lender for the opportunity to borrow), and taxes and insurance (to fund the escrow account; if you are required).

Q: Can I pay my own taxes and insurance on a cash-out refinance loan?

A: It depends. On conventional loans, the loan must meet certain criteria and you must agree to pay either an increased rate and/or monthly fee. However, with FHA loans the government doesn’t allow this option and requires an escrow account to be set up for taxes and insurance.  But putting all your taxes and insurance in your monthly payments ensures that both of these get paid, and you know exactly what monthly payment you can afford.

Q: What is an escrow account?

A: An escrow account is an account that may be required by the loan provider when you opt for a cash-out refinance debt consolidation loan. Your property taxes and homeowners insurance (if applicable) are paid out of this account when they become due. You pay into the account monthly with your mortgage payment.

Q. What are “impounds“?
A. Another word for escrow, impounds are the part of your monthly house payment that cover property taxes and home owners insurance (if required). This monthly amount is calculated by taking your annual payment/premiums and dividing by 12. As described above, for a higher rate you might be allowed to pay insurance and taxes by yourself. However, the general prefer practice is to collect these in monthly installments and pay them when due. This ensures that these are paid on time and prevents tax liens or lapsing of insurance. Typically, at closing, whatever is currently due plus two months extra is collected for reserves or what should have been collected since the last due date for the insurance or taxes plus two months extra for reserves (which will cover any late payments)

Q: What is “title work”?

A: This phrase refers to the process required to ensure that there aren’t any liens or lawsuits on the property, which would prevent a clear transfer of the title.

Q: What can I expect at the closing of my debt consolidation loan?

A: At closing, expect to sign A LOT of documents, including the loan application and others.  You’ll receive copies of all the loan forms. At the conclusion, the title company will distribute the payments to all parties that will receive funds from the transaction. In the case of a refinance, you will receive a check shortly thereafter for any difference between the actual payouts and the loan amount.

Looking For a Way Out if Debt? Sign-up Now For a Free Consultation.

Related posts:

1. How to Erase up to $2M in Debt Tax Free – How The Mortgage Debt Forgiveness Act Works
2. How to Get out of Debt
3. How To Handle Debt Collector Calls
4. Get Out Of Debt In 2010

Tagged as: cash-out refinancing, Credit, Credit Bureau, credit repair, credit report, credit score, Debt Consolidation, HELOC, home equity line of credit, home equity loan, Mortgage, Refinance

Be sure to check out the latest bank rates, cd rates, mortgage rates and top deals on Rate Nerd.