With household debt levels still hovering at around 75% and many families struggling to meet all their commitments every month, it can be very tempting for home owners to “consolidate” all their debts into their home loan – but they need to be really careful that they are not jumping out of the frying pan into the fire.
So says Shaun Rademeyer, CEO of BetterLife Home Loans who notes: “We have seen an increase recently in applications for what the banks call ‘further advances’ – which is when the home owner re-borrows all or part of the amount he has already paid off his home loan to finance something else”.
“Usually the motivation to do this is to pay for additions and alternations, or pay for a child’s tertiary education, but currently the strongest reason being given for further advances is to use the money to pay off other debts and consolidate all borrowings into the home loan account, at a relatively low rate of interest compared to a credit card balance, for example, or car finance.”
However, he says, borrowers need to be careful that they are not pushing up their loan repayments to unmanageable levels by doing this and putting their biggest asset at risk in the process. “If you default on other debts it can result in your car being repossessed, or a judgment being taken against you, which is bad enough. But if you are unable to make the repayments on your enlarged home loan, you could lose your home”.
“Another problem we see is when people who take out further advances for debt consolidation continue to overspend, and before long find themselves in deeper credit trouble than before. Now they have a bigger home loan plus a new credit card balance to pay off.”
Indeed, says Rademeyer, debt consolidation using your home as security should only be undertaken by disciplined borrowers who are really committed to debt reduction. “There’s really no point in starting a debt consolidation programme unless you set goals that you can achieve and you can live with the steps you need to take to achieve them”.
“For a start you need to avoid financing certain items over the full 20-year lifespan of your re-enlarged loan. For example, the repayments on a car usually only last for a maximum of five or six years, so you need to ensure that any car finance amount that you have consolidated into your loan is repaid within the same period of time – or you could end up paying interest over 20 years on a car you don’t even own anymore”.
“In fact, you should aim to pay off the whole additional amount borrowed as a further advance as quickly as possible, and get your home loan liability back to where it was. Simply borrowing the extra and extending the period over which the bond has to be repaid does not represent a real saving – and could actually cost you more in interest in the long run.”
The best course, he says, is to take the money that you were using to pay off your other debts every month and add that to your new bond repayments every month – or at least as much of it as you can possibly spare. This will shorten the lifespan of your refinanced bond and could save you many thousands of Rands in interest .
“In addition, you should be prepared to pay the new property evaluation and bond registration costs for a further advance upfront to avoid the interest charges on those costs over the life of the new loan. And you should make every effort not to take on any new debt while the consolidated loan is outstanding.”
Rademeyer also says it is just as important to obtain the best possible interest rate on a refinanced home loan as it was on the original loan.