When it comes to managing debt, many New Zealanders look for ways to simplify their finances and reduce their monthly outgoings. One strategy that often comes up is consolidating debts, such as car loans, into a mortgage. While this might seem like a good idea at first glance, it’s not always the best financial decision. In this guide, we’ll explore why you shouldn’t put your car loan on your mortgage, and what alternatives you might consider instead.

Before diving into the reasons why this might not be the best idea, let’s first clarify what it means to put a car loan on your mortgage.

A car loan is a type of personal loan specifically designed to finance the purchase of a vehicle. These loans typically have a fixed term (usually between 1 to 7 years) and a fixed interest rate. The loan is secured against the car, meaning if you fail to make repayments, the lender can repossess the vehicle.

A mortgage is a loan used to purchase property, usually a home. Mortgages are long-term loans, often spanning 20 to 30 years, and are secured against the property itself. If you fail to make repayments, the lender can repossess your home.

Consolidating a car loan into your mortgage involves increasing your mortgage amount to pay off the car loan. This means you’ll have one larger mortgage instead of separate mortgage and car loan payments. The idea is that by doing this, you might benefit from a lower interest rate on your mortgage compared to your car loan, and you’ll only have one monthly payment to manage.

While consolidating your car loan into your mortgage might seem like a good idea, there are several reasons why it could be a bad financial move.

One of the main reasons not to put your car loan on your mortgage is that you’ll likely end up paying more interest over the life of the loan.

How Interest Works on a Car Loan vs. a Mortgage

Car loans typically have shorter terms (1-7 years) compared to mortgages (20-30 years). While the interest rate on a mortgage might be lower than that of a car loan, the longer term means you’ll be paying interest for a much longer period.

The Impact of Compound Interest

Mortgages use compound interest, which means you’re not just paying interest on the principal amount but also on the accumulated interest. Over a long period, this can significantly increase the total amount of interest you pay.

When you consolidate your car loan into your mortgage, you’re effectively extending the life of your car debt from a few years to potentially decades. This means you’ll be paying for your car long after it’s lost its value or even after you’ve stopped driving it.

Depreciation of Assets

Cars are depreciating assets, meaning they lose value over time. Most cars lose around 20-30% of their value in the first year and continue to depreciate each year after that. By the time you’ve paid off your car loan (if it were separate from your mortgage), your car might only be worth a fraction of what you paid for it.

When you take out a mortgage, your home is used as collateral. If you fail to make your mortgage payments, the lender can repossess your home. By consolidating your car loan into your mortgage, you’re effectively using your home to secure your car loan.

Increased Risk of Losing Your Home

If you run into financial difficulties and can’t make your mortgage payments, you risk losing your home. This is a much more significant consequence than having your car repossessed. While losing your car would be inconvenient, losing your home could be devastating.

The Emotional and Financial Impact

Losing your home can have a profound emotional and financial impact on you and your family. It’s not just about losing a place to live; it can also affect your credit score, your ability to rent or buy another home, and your overall financial stability.

When you have separate loans for your car and your home, you have more flexibility in how you manage your finances. For example, if you come into some extra money, you can choose to pay off your car loan early, reducing your overall debt and saving on interest.

Limited Options for Early Repayment

If your car loan is rolled into your mortgage, you lose this flexibility. Mortgages often have restrictions on early repayments, and even if they don’t, making extra payments on your mortgage won’t specifically reduce the amount you owe on your car.

Difficulty in Refinancing

If you decide to refinance your mortgage in the future, having a larger mortgage balance (due to the consolidated car loan) could make it more difficult to qualify for a new loan or get a favorable interest rate.

While consolidating your car loan into your mortgage might lower your monthly payments, it doesn’t necessarily mean you’re saving money in the long run.

Lower Monthly Payments, Higher Total Cost

By extending the term of your car loan, you’re spreading the cost over a longer period, which reduces your monthly payments. However, as we’ve already discussed, this also means you’ll pay more in interest over the life of the loan.

Opportunity Cost

The money you save on lower monthly payments could be better used elsewhere, such as investing in your retirement, building an emergency fund, or paying down higher-interest debt.

Consolidating your car loan into your mortgage can make your financial situation more complicated, especially if you decide to sell your home or refinance in the future.

Difficulty in Tracking Debt

When you have separate loans, it’s easier to track how much you owe on each one and how much you’ve paid off. When you consolidate your car loan into your mortgage, it becomes harder to distinguish between the two, making it more difficult to manage your debt.

Potential for Over-Borrowing

Having a larger mortgage might make it tempting to borrow more money in the future, leading to increased debt and financial stress.

If you’re considering consolidating your car loan into your mortgage, it’s worth exploring other options that might be more financially beneficial.

If you’re struggling with high monthly payments on your car loan, consider refinancing it. Refinancing involves taking out a new loan with better terms (such as a lower interest rate or longer repayment period) to pay off your existing car loan.

Benefits of Refinancing

• Lower Interest Rates: You might be able to secure a lower interest rate, reducing the total cost of your loan.

• Lower Monthly Payments: Extending the term of your loan can lower your monthly payments, making it easier to manage your finances.

• Improved Cash Flow: Lower monthly payments can free up cash for other expenses or savings.

If you have the financial flexibility, consider making extra payments on your car loan. This will help you pay off the loan faster and reduce the total amount of interest you pay.

Benefits of Extra Payments

• Reduced Interest: Paying off your loan early reduces the amount of interest you’ll pay over the life of the loan.

• Faster Debt Freedom: You’ll be debt-free sooner, giving you more financial freedom and flexibility.

If you need to borrow money for a car, consider taking out a personal loan instead of rolling it into your mortgage. Personal loans typically have shorter terms and higher interest rates than mortgages, but they also allow you to pay off the debt faster and avoid the risks associated with using your home as collateral.

Benefits of a Personal Loan

• Shorter Terms: Personal loans usually have shorter terms, meaning you’ll pay off the debt faster.

• No Risk to Your Home: Since personal loans are unsecured, you don’t risk losing your home if you can’t make payments.

• Flexibility: Personal loans can be used for a variety of purposes, giving you more flexibility in how you use the funds.

If you’re planning to buy a new car in the future, consider saving up and paying for it in cash. This will help you avoid taking on additional debt and the associated interest costs.

Benefits of Saving for a Car

• No Debt: Paying for a car in cash means you won’t have any debt or interest payments.

• Better Negotiating Power: Having cash on hand can give you more negotiating power when buying a car, potentially allowing you to get a better deal.

• Financial Freedom: Avoiding debt gives you more financial freedom and reduces stress.

5. Seek Professional Financial Advice

If you’re unsure about the best way to manage your car loan and mortgage, consider seeking advice from a financial advisor. They can help you assess your financial situation and recommend the best course of action based on your individual circumstances.

Benefits of Professional Advice

• Personalised Recommendations: A financial advisor can provide personalized recommendations based on your financial goals and situation.

• Expertise: Financial advisors have the expertise to help you navigate complex financial decisions and avoid costly mistakes.

• Peace of Mind: Knowing that you’re making informed financial decisions can give you peace of mind and reduce stress.

While consolidating your car loan into your mortgage might seem like a convenient way to simplify your finances and reduce your monthly payments, it’s not always the best financial decision. By doing so, you could end up paying more interest over time, extending the life of your debt, and putting your home at risk. Additionally, it can complicate your financial situation and limit your flexibility.

Instead of rolling your car loan into your mortgage, consider alternatives such as refinancing your car loan, making extra payments, or taking out a personal loan. If you’re planning to buy a new car in the future, saving up and paying in cash is another excellent option. And if you’re unsure about the best course of action, seeking professional financial advice can help you make informed decisions that align with your financial goals.

Ultimately, the key to managing your debt effectively is to understand the long-term implications of your financial decisions and choose the option that best suits your individual circumstances. By doing so, you can achieve greater financial stability and peace of mind.