Shuffling the debt

Bruce Sellery says using your mortgage to pay off credit card debt can be a wise move, but it’s not a free pass.

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Question

Should I increase my mortgage to pay off credit card debt?

Answer

You might think that this is your “get out of jail free” card that would zap the debt that keeps you locked up in your own little debtors’ prison. While you know in your head that the amount has just been rolled into your mortgage, you feel lighter, freer and more relaxed.

Reduced stress is one benefit of using your mortgage to pay off credit card debt. Done right, it can be a very positive move. But done wrong, rather than getting you out of jail free, you could be extending your sentence even longer.

Lower rates = lower interest costs

First, the good news: In addition to reducing stress, consolidating your credit card debt onto your mortgage will lower your interest costs. Setting aside compounding for the sake of simplicity, look at this example: If you owe $10,000 on credit cards with an interest rate of 19%, you’re paying $1,900 in interest each year. If you move that balance onto a mortgage with a rate of 4% you’ll be paying just $400, saving a whopping $1,500.

Delaying your day reckoning

However, the pro of lower interest costs is offset by a big con: Consolidation can delay your day of reckoning—but you can’t avoid it. Perhaps the biggest problem with this is that it will allow you to postpone dealing with whatever got you into debt in the first place—an “enabler” in the parlance of the addiction treatment specialists.

I recently coached a married couple that had been using debt consolidation to enable their spending addiction for years. How did I know? They brought out their net worth statement and showed me that while their home was worth $400,000 and they had lived in it for 22 years, they had built up virtually no equity. Why? Because they had repeatedly used their mortgage to consolidate their credit card debt.

I felt sick for them. After two decades of paying their mortgage they had nothing to show for it. They were spending more than they were earning, but they were oblivious to the consequences of their behaviour. Debt consolidation may have allowed them to get through some tough times, but because their behavior hadn’t changed, they were on track to spend the rest of their lives behind those metaphorical bars.

Your mortgage as a debt destroyer

Using your mortgage to pay down credit card debt can be a very powerful tool, especially in today’s low interest rate environment. Here are three tips on how to do it right:

  1. Change the way you use credit cards. If you don’t change the behavior that had you build up the debt in the first place, you will be back in the same place in just a few years. Start by taking the credit cards out of your wallet and going cash-only as a way to get a better handle on your spending. Next, analyze your cash flow to see how you can increase your income and/or cut your expenses to free up more money for debt repayment. If you aren’t willing to do these two things, there isn’t much point in using your mortgage to pay off your credit cards, because that change alone won’t likely be enough.
  2. Research your other options. Talk to you bank about what options you have to bring your interest costs down. Consolidating your debt on your mortgage is one option. But you should also consider a traditional low interest rate loan, or a line of credit secured against your house. These options may allow you to pay off your debt faster than the amortization on your mortgage and the faster you eliminate your debt, the less interest you end up paying.
  3. Increase your mortgage payments: If you do choose to change the way you use credit cards, and using your mortgage turns out to be your best option, be sure to increase your mortgage payment to account for the interest savings. You do not want to feel flush after you have done a debt consolidation. You still want to feel somewhat strapped because that will help you keep your spending under control. In the case of the example above, you’d save $1,500 per year in interest. Rather than spending that money, increase your mortgage payment by $200 per month to help you pay down debt faster. You might even consider getting a pre-payment option that will allow you to contribution more to your mortgage in a given year—say 15%. So as you get better at managing your cash flow you’ll have the ability to increase the amount of money you put to pay down your debt.

There is no get out of jail free card, but there is a way to get out of jail faster. And done right, using your mortgage to pay down your credit card debt can be a way to do just that.

ask@moneysense.ca

One comment on “Shuffling the debt

  1. Wouldn't this strategy make even more sense if your mortgage is tax-deductible (on a rental property)?

    Reply

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