There are many potential pros and cons to using a debt consolidation mortgage as a means to pay off and consolidate different kinds of debt, including factors that affect the interest rate, payoff period and tax deductibility. A debt consolidation mortgage may be an equity line of credit or a cashout refinance on a home that allows homeowners to obtain the money required to consolidate their debt into one loan. Either way, a debt consolidation mortgage provides the consumer with the money needed to pay off outstanding unsecured debt such as credit cards and consumer loans.
If using an equity line as a debt consolidation mortgage, the homeowner is pulling the equity built up in the home out by establishing a revolving line of credit. An equity line works similar to a credit card, so the homeowner is charged interest on the balance on the line of credit. As the line gets paid down, it is available for the homeowner to use again.
One advantage to this type of debt consolidation mortgage is the interest rate is lower than standard credit cards or consumer loans and is tax deductible. Another advantage is that even when the line of credit is paid off, the homeowner has the line available for future use in case of an emergency or a future need.
A line of credit, however, has some disadvantages as well. One disadvantage is that when the homeowner sells the home, the line of credit must be paid off. Another disadvantage is that the interest rate on an equity line is typically higher than that of a standard debt consolidation mortgage. This is because these types of lines of credit are generally in second lien position, which makes it riskier for the lender. The riskiness of these lines is passed on to the borrower in the form of a higher interest rate.
A cashout mortgage allows the homeowner to access the equity in the home while also refinancing the first mortgage on the property. The primary advantage of this type of loan is it carries a lower interest rate than credit cards, consumer loans and lines of credit, and is tax deductible. This is also a beneficial situation when the interest rate on the existing first mortgage is higher than the one the borrower can get in a cashout refinance.
The primary disadvantage of a debt consolidation mortgage is the costs involved in establishing the mortgage. Typically, the closing costs on a mortgage are a percentage of the loan amount. This means that the higher the loan amount is, the more the borrower has to pay up-front in closing costs. This type of loan also had to be paid off when and if the house is sold.
Perhaps one of the most significant disadvantages of borrowing against a primary residence to pay off unsecured debt is that it puts homeowners at risk of foreclosure if they are unable to pay the higher mortgage payment. While a homeowner can't lose their home for not paying a credit card bill, they can if they default on their house payment.
Both types of mortgages have the potential to be tax deductible. Typically, a homeowner can write off the interest portion of a mortgage payment on a primary residence. So, whether the homeowner uses an equity line of credit or a first mortgage, a debt consolidation mortgage turns other types of debt that are not deductible into tax deductible items.