Debt consolidation: is a mortgage top-up right for you?

Credit cards, personal loans, car finance and buy now, pay later accounts can add up quickly. Each one has its own interest rate, due date and minimum payment, and keeping track of them all can feel like a second job.

If you own your home and have built up some equity, you may be able to use it to pay off those debts and replace several repayments with one. This is called debt consolidation, and for many homeowners it can reduce the interest they pay. It isn't right for everyone, though, and there are trade-offs worth understanding before you decide.

What is debt consolidation through your mortgage?

Debt consolidation means combining several debts into one loan. When you do this through your home loan, you borrow extra money against your property and use it to pay off your other debts.

In New Zealand, there are two common ways to do this:

A mortgage top-up. You increase your existing home loan with your current bank and use the extra funds to clear your other debts.
Refinancing. You move your home loan to a different lender and borrow a larger amount at the same time.

Some homeowners also use a revolving credit facility, which works like a large overdraft secured against the home. These suit some situations but need careful management.

How much equity can you use?

Your equity is the difference between what your home is worth and what you still owe on it. Lenders measure this using your loan-to-value ratio (LVR), which is your loan amount as a percentage of your property's value.

The Reserve Bank sets rules on how much lending banks can do at high LVRs:

Owner-occupiers generally need to keep at least 20% equity, meaning a maximum LVR of 80%. Banks can make a limited share of their lending above this, so exceptions are possible, but they aren't guaranteed.
Property investors generally need to keep at least 30% equity, meaning a maximum LVR of 70%.

To confirm your home's current value, your lender may ask for a registered valuation.

What lenders look at

A top-up or refinance is a new lending decision, so the lender will assess your application in full. They will usually consider:

Affordability. Under the Credit Contracts and Consumer Finance Act (CCCFA), lenders must make reasonable inquiries to make sure you can afford the loan without substantial hardship. They also check whether you could keep up repayments if interest rates were higher than they are today.
Debt-to-income ratio (DTI). The Reserve Bank limits how much banks can lend to people with high debt compared with their income. Most owner-occupier lending is kept at or below six times gross annual income, and most investor lending at or below seven times.
Credit History: Your credit history is reviewed as part of the lending assessment. A good loan repayment history, along with consistently paying your bills on time, is important.
Income and job stability. Lenders want to see that your income is reliable enough to support the new loan.

It helps to have your documents ready, such as recent payslips, bank statements, photo ID and details of every debt you have. Include credit card limits as well as balances, because lenders usually count the full limit.

What it might cost

Debt consolidation through your mortgage isn't free. Depending on your situation, costs can include:

legal fees
a valuation fee
a break fee, if you're on a fixed rate and change your loan before the fixed term ends
possible repayment of a cash contribution, if your current bank paid you one when you took out your loan and you leave within a set period.

If you're moving to a new lender, they may offer a cash contribution of their own, which can help cover some of these costs. Get these figures in writing before you commit, because break fees in particular are calculated on the day and can change.

Why mortgage interest is usually lower

Home loans are secured against your property, so they carry less risk for the lender. That's why mortgage interest rates are usually much lower than credit card or personal loan rates.

Different types of debt also respond differently to changes in the economy. The Reserve Bank's Official Cash Rate (OCR) has a direct influence on floating home loan rates, while fixed rates are driven more by wholesale market rates. Credit card rates tend to stay high whatever the OCR does, because the lender has no security if you don't pay.

The trade-off: a lower rate over a longer term

This is the part that's easy to overlook. Moving a credit card balance onto your mortgage usually means paying a much lower interest rate. But a credit card or personal loan might be paid off in a few years, while a mortgage typically runs for 25 to 30 years.

Imagine you have $20,000 spread across a credit card and a personal loan. If you move it to your mortgage and only make the standard mortgage repayments, you could be paying it off for decades. Even at a lower rate, that much time can add up to more total interest than if you had cleared the debt faster at the higher rate.

The way around this is to treat the consolidated amount as its own short-term goal. For example, you could keep the top-up as a separate part of your loan and repay it over a shorter period, or keep making the same total repayments you were making before. You still benefit from the lower rate, and the debt is cleared much sooner.

The risks to think about

Your home becomes the security. Credit card and personal loan debt is usually unsecured. Once you move it into your mortgage, it's secured against your home. If you can't keep up with repayments, the consequences are far more serious.

New debt can creep back in. Consolidation only works if it fixes the problem. If credit cards are cleared but spending habits stay the same, it's easy to end up with a bigger mortgage and new card debt as well. Before you consolidate, consider closing or lowering the limits on cards you no longer need, and set up a realistic budget.

When it might make sense

Debt consolidation through your mortgage may be worth considering if:

you have high-interest debt across several accounts
you have enough equity in your home to stay within lending rules
you can comfortably afford the new repayments
you're committed to not building up new short-term debt.

It may be less suitable if you're partway through a fixed-rate term with a high break fee, you're close to paying off your mortgage, or the amount of debt is small enough to clear quickly another way.