Refinancing Personal Debt – The Double-edged Sword

A common story I hear is about homeowners who have recently refinanced their home loan.

They’re feeling financially savvy for wrapping up their maxed-out credit card and personal car loan into the mortgage, at a rate of 4%, as opposed to 15% and 6%. What I want to show you is how this simple process can cost you thousands more, meaning that the interest rate and cash flow savings you obtain are obliterated by increasing the loan term and effectively borrowing to own the car or pay the credit card out over a 30-year mortgage loan term.

Here’s the Math…

Say you have a car loan of $30,000 at 6% p.a. with 5 years remaining on the term of the loan, your weekly repayment is going to be a touch over $133 per week. Refinancing this loan into your mortgage at rate of 4% p.a. makes sense, right? Why pay 6% when you can pay 4%?

You’ve refinanced your $30,000 car loan and the new repayment is only $33 per week, compared to $133 per week. Sounds like a win, right? Hold your horses though. When we take a deep dive we discover that this recently refinanced loan is now tacked onto the home loan, which is spread out over 30 years.

You now have to pay $33 per week for 30 years, which equates to a total loan cost of $51,526 versus your original car loan at 6%, costing a total of $34,746 over the original 5-year term.

The second issue is you are unlikely to own the car for more than 7 years, so you are effectively paying off a debt for a car you no longer own by the time the mortgage is fully repaid, costing you over 30% more than the traditional ‘more expensive’ personal loan. The below illustration demonstrates the profound impact of not understanding the consequences. Where the green shade reflects the more ‘expensive’ personal car loan, the blue shade shows wrapping the loan into the more ‘affordable’ interest rate within the home loan.

The key to taking advantage of refinancing debt into a lower interest rate facility is to either retain the existing repayment rate that you had on your refinanced debts, or to ensure the interest rate savings you obtain are allocated to additional debt repayments rather than consumption.

Refinancing personal loans into a lower rate can appear sensible, but it is important to seek professional advice and understand your payment requirement when consolidating personal debts into your home loan. If you don’t it could cost you many thousands of dollars more. 

If you want to better understand your debt position to ensure you don’t fall into this trap, give the team at Steve May a call and start a conversation today.