HIgh costs of mortgage debt consolidation

Lumping all your debts into one may not be the best way out of trouble [but it may be the onle way as well].
People are putting their homes at risk over relatively minor debts such as credit card balances because they don't fully appreciate the difference between secured and unsecured debt.
"People are taking small, unsecured debts and refinancing them onto their mortgage, which is secured debt," says the co-ordinator of the NSW Consumer Credit Legal Centre, Karen Cox. "But if they create the situation whereby they can't pay their mortgage, they risk losing their house over a small credit card debt basically." [If they don't pay their credit card debt, they will eventually put their home at risk because the creditor can chase the debtor to bankruptcy. The difference is that the consolidated debt can be thousands of dollars cheaper per month than the debts separately, and this is why people can't manage the debt in the first place. The problem is that many mortgage brokers add fees and the Government takes mortgage duty and sometimes even stamping duty, and these extra fees contribute to debt bloat.]
Cox says not every borrower is aware of the difference between secured and unsecured debt or fully appreciates that their consumer debt becomes secured debt when consolidated into a home loan: "We've had comments from a number of consumers who say, 'I didn't know I'd done that and I wish I hadn't, because I'm now struggling to pay my mortgage and I could lose my house."'
Financial counsellor Jan Pentland, of Melbourne's Eastern Access Community Health, says such refinancing is being actively promoted by finance brokers. "But while it seems like an easy and sensible thing to do, there are implications that may not be considered," she says.
Unsecured loans - such as the money a credit card company lends you - don't require any form of security to back the loan in the event you default. The lender relies solely on its judgment that you'll be able to pay in full.
Secured loans are backed by some form of collateral - in the case of a home loan, by the house or unit. In this case, the bank, after following certain preliminary steps, is entitled to repossess your home, sell it and use the proceeds to fulfil the debt obligation.
Cox says it is possible for creditors to take enforcement action on unsecured debts - seeking a writ for levy against property or making you bankrupt and forcing asset sales - but says it's a longer process with opportunities along the way to negotiate.
The Consumer Credit Legal Centre generally advises people to stick with their smaller debts and try to negotiate a revised payment schedule with their original lenders to resolve the problem.
Cox says people in financial stress can be vulnerable to making bad decisions based on poor advice in this regard.
"You've got people specialising in debt consolidation and - while not all these people are necessarily bad - it's an area in which some form of exploitation is quite rife," she says.
In extreme cases, people are charged large fees and commissions - totalling perhaps $30,000 on a $200,000 loan - that are added onto the new loan.
"At the really sticky end", Cox says, a large slice of the loan might be on, say, 12 per cent while the remainder of the debt goes to another lender at 16 to 18 per cent.
"The worst-case scenario for those people who are already in significant trouble on either their credit cards or their mortgage and who then consolidate or refinance into another loan is that it actually turns out to be a lot more expensive than the one they've got," she says.
"So it hasn't solved their issues at all. It might postpone enforcement proceedings but that's about it. A lot of those people go under in a fairly short time anyway and they've lost a whole lot of their equity [in their home]."
Pentland says finance brokers being paid by commission have a vested interest in promoting such loans. "They're not an independent voice and, ultimately, the outcome can be that people eat away at the equity in their homes."
In the middle are people refinancing what should be short-term debt - such as credit card balances - on long-term loans so that their repayments drop, perhaps easing their immediate burden. But the result is that they pay much more over the term of the loan, Cox says.
"Some people make that decision because they're facing enforcement proceedings on the credit card, but it's something they really need to be aware of. It might well be that, if they get advice, they'll manage to make some sort of arrangement with the original creditor on the credit card."
Also in that middle zone are people whose lenders won't let them consolidate their debts in their existing, standard-rate home loan. Some of those people might move to lenders offering "sub-prime" home loans, which come at higher interest rates based on the perceived higher risk for the lender.
Such borrowers need to take care that the saving from lowering the rate on the credit card portion of their debt isn't wiped out by the higher rate on the - almost certainly much larger - home loan portion of their debt, Cox says.
"People have to be very careful to get advice from an independent source before they do anything - particularly if they're under pressure from existing creditors," she says.
The Australian Securities and Investments Commission provides details of free, independent counselling services at its consumer website, http://www.fido.asic.gov.au/ (search for "financial counselling"). Pentland says the calculators available on many financial websites allow borrowers to do their own sums on possible outcomes.
Cox says some people will have to ask themselves whether, in the end, it would be better to sell their home.
"It's a really hard decision, but when you're being offered finance on really bad terms, once you get to that point, it's better to think, 'I'm going to make a strategic retreat here ... If I sell up now at least I'm going to walk away with some cash.' If you keep refinancing, there are people out there who, literally, are out to strip you of your equity.
"You're only going to end up worse off in the long run, because if you lose your house and your equity too that's just devastating."
Selling up is an extreme solution but a valid one if you've done a thorough assessment of your overall financial position and it just doesn't add up, Pentland says.
"You have to do some serious thinking - if you were to refinance, is that going to resolve the problem, or is it just putting off the day when you're going to have to face this?"
THE SNOWBALL EFFECTConventional wisdom says you should pay off your most expensive, non-deductible debt first. In other words, you should apply any extra money to your credit card debt first, ahead of a personal loan or home loan and definitely before an investment loan on which you can claim the interest expense as a tax deduction.
However, if personal debts have got out of hand another strategy is to pay off your smallest debts first.
The strategy involves paying the minimum required on all of your debts, then finding an extra amount to apply to the smallest of those debts. Once you've paid that first debt off, you apply its minimum repayment and the extra amount to the next smallest debt and so on.
The idea is that the amount you pay on the next debt in line snowballs each time a payment is made.
Plus there's a psychological benefit in actually seeing the debts being knocked off one by one, rather than having one large, consolidated debt hanging over your head for what seems like forever.
Asked what she thinks of the snowball strategy, named by US finance author David Ramsey, financial counsellor Jan Pentland says she thinks it does have psychological value.
"It cuts across the notion of paying the most expensive debt first but there's an effect when people see themselves making some progress," she says. "And that encourages them to do more."Source: The Age