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Consolidating Debts

Why Consolidating Your Unsecured Debt into your Mortgage or a Secured Line of Credit May Not Be a Good Idea

These are challenging times for nearly everyone. Not only is the current health situation causing anxiety and worry, but there are also significant economic issues occurring today. The unemployment rate in Canada is close to the worst it has ever been, and household debts are rising, despite actions by the Canadian government to provide support and relief.

According to the Bank of Canada, household debt as a percentage of GDP has risen from 58 percent in 2000 to 99 percent in 2019. Projections state that it could rise to as high as 130 percent due to the pandemic. This means more and more people will be borrowing more and more money. These large amounts of debt can be tough to pay back, especially during challenging economic times.

With many Canadians are struggling to pay their debts, some Canadian banks have begun offering customers a secured line of credit or the option of refinance their mortgage at a low interest rate, usually offering to roll a person’s unsecured debts into their mortgage. These options are often presented to those with higher unsecured debt and house equity.

At first glance, this situation seems like it could be beneficial. Secured lines of credit and mortgages typically have lower interest rates than unsecured debts like credit card debt. However, much like with nearly every financial decision, it’s not a “one size fits all” solution. Depending on your situation, accepting the bank’s option and taking this step may not be a good idea.

What Rolling Unsecured Debt into a Mortgage or Secured Line of Credit May Do

Before you decide to roll your unsecured debt into a secured line or credit or your mortgage, it’s important to consider all factors.

One important fact to consider is how rolling you debt into your mortgage could cause significant consequences going forward. By rolling your debts into your mortgage, you decrease the amount of equity you have in your home (since you’re increasing the amount you owe on your mortgage). If you do this, you may still be able to afford the monthly payments, but if house prices were to fall, you could end up owing more money on your mortgage than your house is worth. That would make it nearly impossible to sell your home without losing a lot of money including mortgage prepayment penalties.

Recently, the Canada Mortgage and Housing Corporation (CMHC) reported that the pandemic will lead to a “historic recession in 2020” and stated that it has seen “significant falls in indicators of the housing market.” It forecasts that home prices will fall by between nine and 18 percent from where they were before the current health situation and aren’t expected to fully recover until at least 2022.

In addition, secured debt such as mortgages or secured lines of credit cannot be included in bankruptcies or consumer proposals. While starting either of these processes may not be what a person necessarily wants to do, in these challenging economic times, these options could be a way to resolve debt problems.

The CEO of the CMHC recently told a parliamentary committee that the country is headed toward a “debt deferral cliff” and estimates that roughly 20 percent of households could request mortgage deferrals during the course of the pandemic. This is up from the current rate of 12 percent. In these difficult times, it’s important to make financial decisions that are right for your unique circumstances.

Every person’s situation is a bit different. In some cases, refinancing could be great. However, for others, refinancing could result in a situation where you’ll still have to file a consumer proposal while trying to pay off your outstanding mortgage debt. This scenario could be much more costly compared to doing a consumer proposal alone. In addition, if a person refinances and can’t afford the higher secured debt payments, they could lose their home and may have to file for bankruptcy as well.

If your bank is encouraging you to refinance and roll your unsecured debts into your mortgage or a secured line of credit, you should be skeptical. What’s good for the bank may or may not be good for you, especially in these uncertain times.  Refinancing could start you down a path that ends with you losing your home, having to file bankruptcy, or in other financial trouble. Talk to a Licenced Insolvency Trustee or a trusted advisor before taking the bank up on their ‘offer’.