As a Homeowner, you can often borrow beyond your mortgage, taking on additional personal debt for home renovations, household furnishings, and general living expenses. As long as your income remains sufficient to service your debt, it’s not a problem. But what are your options when your debt gets out of control? For a homeowner who owes money on credit cards and unsecured lines of credit and also has equity in your home, the question becomes even more complicated.
Is it better to get a second mortgage and refinance or is selling your home and downsizing a better option?
The most significant problem with refinancing is that it doesn’t reduce total debt and, therefore, may not solve your debt problem. Refinancing $70,000 in credit card debt with a second mortgage may lower the interest paid, but the total debt remains unchanged.
Refinancing generally works best when it can be used to refinance all unsecured debt. Borrowing for a second mortgage to repay $20,000 in credit cards when you have $50,000 in total credit card debt, is only a partial solution, leaving you, the home owner with higher mortgage payments as well as very high credit card payments.
Another problem with refinancing occurs when the second mortgage moves you into a high-ratio mortgage. An analysis of all homeowners who filed a bankruptcy or consumer proposal shows that 9 out of 10 of those homeowners carried a high-ratio mortgage at the time of their insolvency. The average mortgage amounted to 92% of the net realizable value of their home, so they had minimal equity.
However, it’s not necessarily a refinanced, high-ratio mortgage that’s the most significant problem. The average insolvent homeowner owes an additional $73,500 in unsecured debt, and it is that unsecured debt that becomes the trigger for personal bankruptcy. In other words, a high-ratio mortgage means you are also high-risk. If refinancing does not also solve the underlying budgetary problems, you are likely to continue to rack-up new credit card debt to replace the old.
Alternatively, if you have sufficient equity to cover all of your unsecured debt, you can afford the resulting monthly payments, and you want to keep your home, refinancing is a reasonable option. However, you should understand that refinancing converts unsecured debts into a debt secured by your home. If you don’t pay your unsecured debts you may risk a wage garnishment, but if you can’t pay secured debts, like a second mortgage, you risk foreclosure. That’s a significant risk.
If that risk is too significant, you can also consider two other options:
Not everyone qualifies for a consumer proposal so professional advice is required but, for many insolvent homeowners, it’s a great solution. The proposal payment ($500 per month in this example) is often a lot less than the minimum payments on $70,000 in unsecured debt, so the debtor’s cash flow improves immediately, making it more likely they can maintain their mortgage payments. It’s a win-win situation.
There are also instances where a debtor chose to do both: downsizing their home using the equity from the sale to make a proposal to their creditors. In this situation, they have the best of both worlds, their debts are eliminated and their budget is balanced.
The choice should be based on sound advice from appropriate professionals. A Buckingham Realty Sales Representative can advise you as to the value of your home, any equity they may foresee, and provide housing alternatives to consider. A trustee can advise on the financial impact of a second mortgage versus a consumer proposal. Only after weighing all of this information can a client make an informed decision.
If you are considering selling your home or would like a Market Evaluation of your home, contact one of our Real Estate Sales Representatives 519-948-8171 or by clicking http://www.buckinghamrealty.ca/what-is-my-home-worth