Can I Consolidate My Debt Into a New Mortgage?

Even the simplest framing of debt – good debt vs. bad debt – can be more complex than it seems. It’s small wonder why debt reigns as the biggest issue in so many people’s lives.

A mortgage or student loan is expected to benefit your long-range financial health so, it is considered good debt.

Credit cards and payday loans are the bad debt villains that leave you tied to the train tracks.

So the prospect of consolidating some bad debt into a mortgage has its appeal for first-time buyers as well as existing homeowners.

But just know that while debt consolidation in a mortgage is certainly possible and might make financial sense in specific situations, it often requires a larger down payment, could mean paying more in long-term interest, and poses certain risks.

“Consolidating debt in a new mortgage can be a viable option for some individuals, but it’s essential to carefully weigh the pros and cons, considering one’s unique financial situation and goals,” Young Pham, a financial advisor and financial analyst affiliated with BizReport, said.

“First-time homebuyers face additional challenges due to their limited financial history and down payment constraints, making it crucial for them to seek professional guidance when considering debt consolidation within a mortgage.”

How Does Consolidating Debt Into a New Mortgage Work?

Consolidating debt in a mortgage is a type of cash-out refinancing that allows homeowners to borrow more than they owe on their current mortgage and use the difference to pay off car loans, student loans, credit cards and other debts.

A homebuyer who wants to consolidate debt in a mortgage must make a downpayment of sufficient size to meet the maximum loan-to-value ratio after consolidation.

The loan-to-value (LTV) ratio compares the amount of your mortgage with the appraised value of the property. A higher down payment equals a lower LTV.

An example: the home you want to purchase is $200,000, you have  $20,000 to put down and want to consolidate $10,000 of credit card debt. That $180,000 loan you would’ve had without consolidating debt is now $190,000 with the consolidated debt payoff.

Depending on your lender’s requirements, the increase in LTV might exceed the max ratio allowed. No deal.

In the case of a first-time homebuyer, rolling debt into a mortgage can be trickier. Not having the equity built up in an existing home and the history of timely mortgage payments over a number of years, a first-time homebuyer who wants to consolidate debt in a mortgage will likely need a larger down payment and a good credit score (670 or above.)

“First-time homebuyers are typically in the process of building their credit and may have a lower credit score compared to someone with an existing mortgage,” Mark Buskuhl, founder and CEO at Ninebird Properties in Dallas, Texas, said. “This could also impact the terms and rates they are offered for a consolidated mortgage.”

Can You Consolidate Car Loans Into a New Mortgage?

Yes, it’s possible to consolidate auto loans into a new mortgage. In fact, in certain situations rolling a car loan into a mortgage could help a homebuyer decrease his or her debt-to-income ratio and better position them for a mortgage.

Your debt-to-income ratio (DTI) is all your monthly debt payments divided by your gross monthly income. Lenders use DTI to measure your ability to pay back the money you borrow.

Typically, mortgage programs require a DTI ratio of 43% or less, including the new mortgage payment. You might get a loan with a higher DTI, but it would come at a higher rate. The ballpark for the maximum percentage dedicated to your new mortgage payment is 28%.

If there’s not much difference in interest rates between a new mortgage and an existing car loan it might make more sense to keep your auto loan separate.

Can You Consolidate Credit Card Debt Into a New Mortgage?

It’s possible to consolidate credit card debt into a new mortgage. It might well sound like a great deal, too. If you can get a good interest rate on a mortgage loan and you’re carrying credit card debt at 20%, you might think it’s a slam dunk to consolidate that bad debt.

But turning unsecured debt into secured debt can be risky.

Taking on a bigger mortgage payment could strain your finances with far greater consequences than defaulting on credit card debt. You could put your home at risk.

But even if you’re able to manage your mortgage payment, consolidating credit card debt in a home loan could backfire if you continue to run up balances on your credit cards. Better you seek nonprofit credit counseling for help paying off credit card debt.

Pros and Cons of Consolidating Debt Into a New Mortgage

Financial experts hesitate to make sweeping statements about consolidating debt into a new mortgage without knowing the specifics of each situation. But all agree there are advantages and disadvantages, generally speaking.

Pros

• Lower interest rate on your debt. That was certainly the case when mortgage rates fell as low as 2.65% in January 2021. It’s still the case even with rates having more than doubled over the past 18 months.
• A single manageable payment. A fixed payment can make it easier for some people to manage their finances. Making on-time payments is good for your credit score.
• Freeing up cash for other expenses. “You may be able to lower your monthly payments and have more disposable income available for things like home renovations, education costs or emergencies,” Buskuhl said.
• Tax benefits. In cases where you itemize on tax returns, mortgage interest can be deductible.

Cons

• Higher down payment required. You may be better off in that case using a portion of the downpayment to pay off debt separately.
• Higher overall costs. While you could have lower monthly payments, consolidating debt into a new mortgage could result in paying more interest over the long term.
• Risk of losing collateral. One reason mortgage loans carry lower interest rates than unsecured debt is the bank can take your house if you foreclose on your loan.
• You can’t deduct the mortgage interest tied to your non-mortgage debt payoff.
• You might pay a higher interest rate than you would have without the consolidated debt in your mortgage.
• Doesn’t address spending habits. If out-of-control spending is the underlying issue in amassing debt, you could consolidate debt and find yourself in even more financial trouble, just with a bigger mortgage loan this time.

Get Help with Debt Consolidation

Consolidating debt in a new mortgage might work for certain individuals depending on their home equity, credit rating and financial goals. But there are downsides.

“While rolling debt into a mortgage has its advantages, in some cases, might be better to (consider) a debt consolidation loan,” Louis Czerwinski, President and CEO of Allegiant Wealth Management, said. “Separate from the mortgage, it can be tailored specifically for debt consolidation; (Also consider) Debt Management. Offered by nonprofit credit counseling agencies, it can provide structured payment plans and possibly reduce interest rates.”

You can reduce the interest you pay on credit cards and other unsecured debt – and get your debt paid off faster than you might on your own – in a Debt Management Program offered by a nonprofit credit counseling agency like InCharge Debt Solutions.

If you need help with debt consolidation, nonprofit credit counseling agencies offer that and more: housing counseling, bankruptcy education, and budgeting advice.

A consultation with a nonprofit credit counselor can address the specific pros and cons of consolidating debt in a mortgage, and, more generally, help people navigate the life-long challenge of managing debt.