The Refinance Trap of Debt Consolidation
As a Long Island mortgage broker, for years I have been advising past and potential new clients on the advantages of refinancing their current mortgage as a tool for debt consolidation.
The theory behind this promoted two advantages to the borrower.
The first is that a borrower could wipe out high interest revolving credit debt and fold it into a new mortgage with a much lower interest rate.
This could save the borrower hundreds of dollars per month.
The second advantage is that the interest on consumer debt is not tax deductible while mortgage interest is tax deductible, thus lowering the borrower's income tax debt.
This appeared to be a win-win situation.
The borrower was able to lower the monthly debt and save money on taxes.
Based on what has happened over the past 2 years, Long Island mortgage brokers, such as myself, probably did their clients a disservice in encouraging them to refinance.
What is wrong with refinancing as tool for debt consolidation? The answer is plenty.
First of all, many borrowers, when they did refinance would have a higher mortgage and a higher mortgage payment than they did before.
This was offset by the savings they would have by wiping out their revolving consumer debt, leading to a lower monthly expenses overall.
This was a trap.
Quite often, the borrower would start using the credit cards again and go back to the same consumer debt they had before.
Now they would have the same monthly payments on their credit cards with a higher mortgage payment.
This only increased their debt burden, not lessen it.
If home prices were rising and their credit remained good, they could refinance again, setting off another round of higher mortgage balances, higher mortgage payments and diminishing equity on their home.
This was strategy heading for disaster.
Here on Long Island mortgage balances were going up and so were home prices.
Finally, when the gravy trained stopped, borrowers could not refinance any more and were stuck with a debt burden they could not handle.
Instead, we should never told them to refinance as means of lowering payments.
Suppose they never refinanced.
There would have come a point where their credit cards would have been maxed out and they could not incur any further debt.
Responsible spending would have been imposed on them.
Secondly, even if they were responsible borrowers, suppose they suffered a loss of income and could not pay the consumer debt and mortgage payments.
At least the borrower could just make the mortgage payments and still have equity on the home.
A borrower could just not make the consumer debt payments.
Of course, there may been collections and judgments, but the borrower would not lose the home.
By refinancing and throwing consumer debt into the mortgage, the borrower does not have this option.
In many parts of the country as well as Long Island mortgage foreclosures have occurred precisely for this reason.
I still see many ads extolling the virtue of debt consolidation by refinancing.
I believe this kind of marketing should stop.
It is destructive to the borrower.
If a borrower can actually lower their mortgage payment by refinancing, that is fine.
Otherwise, the borrower is being led into a trap that could lead to the loss of their home.
The theory behind this promoted two advantages to the borrower.
The first is that a borrower could wipe out high interest revolving credit debt and fold it into a new mortgage with a much lower interest rate.
This could save the borrower hundreds of dollars per month.
The second advantage is that the interest on consumer debt is not tax deductible while mortgage interest is tax deductible, thus lowering the borrower's income tax debt.
This appeared to be a win-win situation.
The borrower was able to lower the monthly debt and save money on taxes.
Based on what has happened over the past 2 years, Long Island mortgage brokers, such as myself, probably did their clients a disservice in encouraging them to refinance.
What is wrong with refinancing as tool for debt consolidation? The answer is plenty.
First of all, many borrowers, when they did refinance would have a higher mortgage and a higher mortgage payment than they did before.
This was offset by the savings they would have by wiping out their revolving consumer debt, leading to a lower monthly expenses overall.
This was a trap.
Quite often, the borrower would start using the credit cards again and go back to the same consumer debt they had before.
Now they would have the same monthly payments on their credit cards with a higher mortgage payment.
This only increased their debt burden, not lessen it.
If home prices were rising and their credit remained good, they could refinance again, setting off another round of higher mortgage balances, higher mortgage payments and diminishing equity on their home.
This was strategy heading for disaster.
Here on Long Island mortgage balances were going up and so were home prices.
Finally, when the gravy trained stopped, borrowers could not refinance any more and were stuck with a debt burden they could not handle.
Instead, we should never told them to refinance as means of lowering payments.
Suppose they never refinanced.
There would have come a point where their credit cards would have been maxed out and they could not incur any further debt.
Responsible spending would have been imposed on them.
Secondly, even if they were responsible borrowers, suppose they suffered a loss of income and could not pay the consumer debt and mortgage payments.
At least the borrower could just make the mortgage payments and still have equity on the home.
A borrower could just not make the consumer debt payments.
Of course, there may been collections and judgments, but the borrower would not lose the home.
By refinancing and throwing consumer debt into the mortgage, the borrower does not have this option.
In many parts of the country as well as Long Island mortgage foreclosures have occurred precisely for this reason.
I still see many ads extolling the virtue of debt consolidation by refinancing.
I believe this kind of marketing should stop.
It is destructive to the borrower.
If a borrower can actually lower their mortgage payment by refinancing, that is fine.
Otherwise, the borrower is being led into a trap that could lead to the loss of their home.
