Dear Lifehacker, My fiancé and I recently moved back with our parents to save money for a house. We currently have a car on finance, and a personal loan for wedding deposits. My parents are advising us to pay off our loan FIRST before even looking at a house, however my fiancé’s parents are simply advising us to save up a deposit for a mortgage and then roll the loan into that mortgage so it's only one payment. Thanks, Lil Aussie Battler.
This is actually a more complex situation than it seems, with a lot of factors based on your specific financial situation, location and the numbers involved.
That said, we have some general advice on the pros and cons of each options, but you are best to speak to a financial adviser before making any decisions.
That car finance and personal loan is costing you money in interest, which can add up to a significant amount over time. In terms of pure savings, it’s best to pay off the loans as quickly as possible, then save a deposit. Make sure to pay off the loan with the highest interest rate first. This reduces the overall amount of money spent on interest, and will give a bigger deposit over time.
The flip side is that by not paying off the other loans, you can save that house deposit sooner. It will cost more overall, but spread out over a longer time period.
This is important as there is a potential cost to not buying a house sooner, rather than later. In a rising property market, waiting longer to buy a house can mean it will end up costing more overall than buying earlier. Of course, depending where you live, prices may not increase much while you save.
One downside is that having a personal loan and car finance will impact your borrowing capacity. The bank will take the car fiance and personal loan repayments into account and offer you less than if you had no loans at all. Of course, if the bank will still lend you enough to buy your property of choice, this is not a problem.
As your fiancé's parents have mentioned, another potential benefit to not paying off the loans first is that you may be able to roll them into your mortgage. This is called debt consolidation, and the benefit is not that it makes for a single payment, but that you can often reduce the amount of interest you pay overall.
Say your car and person loans have a 10% interest rate (this is an example only), while your mortgage is only 5%. By paying off the 10% interest loans with money from the mortgage, you halve the amount of interest payable. Over time, this can quickly add up and save decent amounts of money.
The are a few caveats though. Some car and personal loans have penalties for early repayments. You need to take these into consideration when crunching the numbers on what options saves the most money.
It’s also very important to consider how your consolidated debts are structured, and how you plan to pay them off. If you only make the minimum repayments, consolidation of debts can actually cost more in interest over the life of the loan.
This is because while that 10% interest on a personal loan is higher than the 5% of a mortgage, the personal loan might have a loan period of 5 years, versus the 30 for a mortgage.
By paying the loan over at a reduced interest rate over a longer period, the minimum payments are reduced, and you have more useable cash flow. But to actually save interest, you need to pay off the consolidated loan faster than the minimum repayments.
For example, if you keep paying the same higher 10% loan repayments after consolidating it into the 5% mortgage, then you will pay less interest overall. If you just pay the minimum amount, the amount of interest over 30 years might be more than what would have been payable on the original loans.
Another factor to consider is that not all banks will allow you to consolidate your loans, and even if they do, they may charge more interest than if the loans are not consolidated.
In the end, the potential options are a mess of calculations based on your specific financial situation.
That said, rolling the loans into a mortgage can be a very useful way to save some money, and is well worth considering. Just speak to a financial adviser about your exact situation before making any decisions.
Do you have multiple loans or a mortgage? Tell us about your financial choices in the comments.
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