Pros and Cons of Debt Consolidation

May 6, 2002, Revised December 1, 2006, Reviewed July 12, 2007, March 30, 2009, March 2, 2011

Use a Debt Consolidation Calculator

Whether or not to consolidate debt is a complicated question. To help in answering it, I have developed three debt consolidation calculators designed for three categories of borrowers:

*1a, Debt Consolidation Calculator For Home Purchasers, is for those about to purchase a house who may want to consolidate non-mortgage debt in the purchase mortgage.

*1b, Debt Consolidation Calculator For Home Owners With One Mortgage, is for those with an existing first mortgage who may want to consolidate non-mortgage debt, either by refinancing the first mortgage to include the non-mortgage debt, or by taking out a new second.

*1c, Debt Consolidation Calculator For Home Owners With Two Mortgages, is for those with existing first and second mortgages who have a variety of consolidation options.

+Status Quo - means you make no change.

+Consolidate Non-Mortgage Debt in First - means that you consolidate your existing non-mortgage debt by doing a cash-out refinance on your first mortgage, leaving your second mortgage as it is.

+Consolidate 2nd Mortgage in First - means that you consolidate your existing second mortgage by doing a cash-out refinance on your first mortgage, leaving non-mortgage debt as it is.

+Consolidate Non-Mortgage Debt and Second Mortgage in First - means that you consolidate both your existing non-mortgage debt and your second mortgage by doing a cash-out refinance on your first mortgage.

+Consolidate Non-Mortgage Debt in Second - means that you consolidate your existing non-mortgage debt by doing a cash-out refinance on your second mortgage, leaving your first mortgage as it is.

What the Debt Consolidation Calculators Tell You

The calculator provides two types of information about each of these options. One is the total monthly payment, which consists of mortgage payments, mortgage insurance premiums if any, and non-mortgage debt payments if any. Borrowers on tight budgets must be concerned with the monthly payment, but it should not be the major determinant of their choice. It fails to reflect differences in tax savings or debt reduction as between the options.

The second type of information the calculator provides about all the options is their total cost over a period specified by the user. If the user’s time horizon is, say, 5 years, the total cost of each option is the sum of the monthly payments over 5 years including lost interest, less the tax savings and reduction in total debt over that period. Minimizing this cost should be the borrower's major objective.

An Example of Debt Consolidation Analysis

"I have two mortgages plus a lot of short-term debt with high interest rates. Because my house has appreciated substantially in recent years, I’m sure I can save money by consolidating the short-term debt into one of my mortgages, but which one?"

When I entered the numbers you sent me, I found that consolidating both the non-mortgage debt and the second mortgage in a new first mortgage resulted in the lowest monthly payment. It was $1446 compared to $1790 under the status quo. However, this consolidation option raised total costs over 5 years from $56,681 under the status quo to $61,058. Consolidating in this way would be selling out your future wealth for a lower payment, which I view as a pact with the devil.

The better alternative would be to consolidate your non-mortgage debt in a new second mortgage, leaving the first mortgage alone. The payment would be $1549, which is higher than the payment under the comprehensive consolidation option, although well below the status quo payment of $1790. More important, the total cost would be the lowest of all the options at $54,867.

The Aftermath of Debt Consolidation

A critical question is what borrowers do after they consolidate? The borrower in the example above should use the monthly savings of $241 to accelerate the pay down of principal on her second mortgage.

Unfortunately, many borrowers in this situation interpret a payment-reduction consolidation as a license to take on more non-mortgage debt. A few years later, they look to consolidate again. If their house has appreciated enough, they may be able to, but sooner or later they run out of equity. Then they write me letters like this one.

"We kept adding to our second mortgage to pay off credit card debt…the rate is now up to 13.75%…we don’t have enough equity to break even if we sell... we feel trapped".

The trap was of their own creation. Don’t let it happen to you. If you feel yourself weakening, you might try joining a debt consolidation community at

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