September 5, 2017

If you have a $200,000.00 mortgage at 3% interest amortized over 25 years with a five year term, your monthly payments would be about $946.00. During the five year term you will pay about $27,739.00 in interest.  If you had to pay the same mortgage at the rate of 6% over the same term, you would pay about $1,280.00 per month and a total of $56,450.21 (more than twice as much) in interest.

That is almost $1,000.00 per month in interest – or 8 all inclusive trips per year to the Caribbean.  Certainly food for thought isn’t it?

But let’s not stop there – many people restructure their unsecured debt (credit cards, loans and lines of credit) by wrapping them into a mortgage but does that save you money?  Remember you are taking a 48 month loan and now stretching it over 25 years.

Consider the following example:

Suppose that I am paying a mortgage of $200,000.00 as above at 3% interest.  I have a consolidation loan with 24 months left to run at $350.00 per month and I have a $10,000.00 line of credit and a balance of $5,000.00 on a credit card.  Currently because I am making extra payments of $100.00 per month on my credit card and my line of credit this is how things look for me:

  • My mortgage payments are $946.00 per month and I will have that paid in 25 years
  • My loan payments are $350.00 per month and that will be paid in 2 years
  • The line of credit is costing me $400.00 per month; and
  • The credit card is costing $250.00 per month.

In total I am paying $1,946.00 per month for the next two years before I see that amount begin to become reduced.  When I have finished paying off my loan, my credit card and line of credit I will have paid about $4,000.00 in combined interest charges.

What would happen if I wrapped that debt into a new mortgage at the same interest rate, term and amortization period?

My monthly payment would be about $1,057.00 and in total over the next five years.  As a result over that term I would pay $30,984 in interest charges.  That would be about $3,245.00 more interest on the mortgage over the next five years than if I didn’t consolidate my debts.  In effect it seems that I would save the $4,000.00 in interest that I would be paying if I just paid the debt without the consolidation.  At least that is as it appears at first blush.

The problem is that the mortgage is still going to continue over yet another 20 year term and the total interest paid will be $93,769.00 versus $83,947.00 over the full life of the mortgage.  In other words the consolidation just cost me $9,822.00 in interest charges which amounts to an additional $5,822.00 out of pocket versus just paying the debts in the ordinary course.

If interest rates were to increase to 6% how would things look?

If interest rates were to increase, as we have seen in the first paragraph, the result could be disastrous.  The total interest payable over the life of the mortgage would be about $205,398.00 or a mere $63,055.00 over the initial five year term.  The payment of interest is insidious especially when calculated over protracted periods of time.

The whole point is that moving debt around and amortizing it over longer terms does not necessarily lead to either a reduction in debt or more affordable monthly payments.  Whether you are insolvent or not, speaking with a trustee in bankruptcy can be useful to help you to understand how to best tackle your debt, especially if it is becoming worrysome.