Does consolidating debt into my mortgage save money?

In Canada, folding high-interest debt into your mortgage usually lowers your rate and monthly payments, but whether it saves money overall depends on how fast you repay the debt. Spreading a short-term debt over a 25-year amortization can mean paying interest for much longer. The lower payment frees up cash flow either way.

How debt consolidation into a mortgage works

You refinance your mortgage for a larger amount and use the extra to pay off credit cards, lines of credit or car loans. With a bank or other federally regulated lender, the new mortgage can go up to 80% of your home's appraised value. You then have one payment, usually at a much lower rate than unsecured debt.

The catch is the amortization, the time it takes to pay off the loan. Credit card debt might otherwise be cleared in a few years. Folded into a mortgage, the card debt is paid off over the same 20 or 25 years as the rest, unless you choose to pay it faster.

A worked example of consolidating card debt

These figures use illustrative rates only, not quotes: an illustrative 20% on credit cards and an illustrative 5% on the mortgage.

You carry $30,000 on credit cards. At an illustrative 20%, the interest alone is about $500 a month.

Rolled into your mortgage at an illustrative 5% over 25 years, that $30,000 adds about $174 a month to your payment. Over the full 25 years, though, the rolled-in debt costs about $22,300 in interest.

If instead you put the same $30,000 on a 5-year schedule at an illustrative 5%, the payment would be about $565 a month and the total interest about $3,900.

So consolidation saves the most when you keep paying close to what you paid before. Pocketing the difference stretches the debt over decades.

The costs and risks to weigh

• Prepayment penalty if you refinance mid-term, usually the higher of three months' interest or the interest rate differential on a fixed mortgage.
• Legal and appraisal costs for the new mortgage.
• The stress test: with a federally regulated lender, you must qualify for the larger mortgage at the greater of your contract rate plus 2 percentage points, or 5.25%. Paying off debts can help your ratios.
• Behaviour: if the cleared cards fill up again, you end up with a larger mortgage and new debt.

Which route to try first

Bank, credit union or monoline refinance is the first option when you have the equity and qualify. A HELOC can work too, but if you pay only the interest, as many HELOCs allow, the debt does not go down.

If your credit or income does not fit, an alternative lender or a second mortgage may help. Either one usually costs more than a bank refinance, with fees disclosed in writing before you commit.

An alternative lender or a second mortgage makes sense only if the new cost is clearly below what you are paying now, with a plan to move back to a bank lender.

What to do next

To compare your current payments with a consolidated mortgage, try the debt consolidation tool; results are estimates only, not an offer or advice. Or use our call-me-back form and we will go through the numbers with you.