Question of the week: Should I refinance to pay-off debt, like my car and credit cards?
Answer: This question came in after last week’s question (should I refinance to pay-off my equity line?), and the short answer is the same as last week’s: Yes. No. Maybe.
As a rule it is not wise to use your home’s equity to pay-off consumer debt. Using home equity for consumer debt hurt a lot of people during the housing bubble. Families were increasing the mortgages on their homes to buy boats and/or to pay off credit cards that were run up to pay for extravagant or excessive consumer goods or vacations. Our term for this is “eating equity.”
The primary issue with eating equity is too often after clearing off their debt with a newer, larger mortgage, there was no alteration in spending habits so in a year or so they would look for another mortgage, increasing their balance to pay-off another round of consumer debt racked up in restaurants, sporting goods stores and local malls. And a cycle started where by the time real estate values crashed families that had bought a house in 2002 for $300,000 with a $240,000 lost it in 2009 with $450,000 mortgage they could not, or would not, pay.
That said, there can be an argument made to refinance and use proceeds to lower other debt.
For instance you have incurred one-time extraordinary expenses for emergency home repair, college expenses, helping out a family member or medical expenses. Or perhaps you did have a period of excessive spending on consumer goods and services, but have curtailed the spending habits and after trying for a few years to reduce the debts have found you not making a very good dent in the balances. If one of these is the case then using a new mortgage for debt relief may be a sound financial decision.
When going through a debt consolidation refinance consultation it is important to discuss the reasons for the debt accumulation, and also make certain that there is a very strong commitment to ensure that once the debt is paid off it is not temporary; i.e. that the accounts that were paid off will not have large balances again in the near, middle or long term.
As with most mortgage questions the answer then becomes a math problem that involves current home value, amount of mortgage the value will support, current debt outstanding and total monthly payments. We then look at expected net equity that can be used to pay-off debt, if this is enough to pay-off all the outstanding debt, and if not targeting which accounts to pay-off that will provide us the greatest payment relief. Note my approach is to eliminate the highest payments, not the highest rates or necessarily balances. If you have one card with a $14,000 balance and a $200 payment and two cards at $7000 each with $300 payments each I would suggest paying of the two cards saving $600 per month instead of one card and saving $200 per month.
Part of the consultation is what to do with the money saved every month, ideally the savings goes to pay-off remaining debt and then put the money into savings.
Here is an example of clients we have helped:
Due to business issues they had accumulated about $60,000 in revolving debt with payments of about $1500 per month, plus they had two auto loans totaling $1200 per month. They were not late on any of their payments but had a hard time making more than the minimums and were unable to save. As well they have young children and were unable to put money away for college.
Because of the equity they had in their home we were able to refinance their mortgage of about $400,000 with a payment of about $2100 per month to a $475,000 mortgage with a payment of just under $2400 per month. We increased their mortgage payment almost $300 per month but were able to pay off all the credit cards and one of the cars, lowering their monthly consumer debt payments from $2700 per month to $575 for one car with just under two years remaining. Total savings for the family almost $2000 per month, which they divided into savings account and two 529 accounts for their kids. Since the refinance about a year ago they have been paying off their credit monthly and spending what they earn as well as building their savings.
Not everyone will have such dramatic savings by consolidating their debt, but the savings can still be pretty dramatic. The key however is to ensure that the use of your home’s equity to consolidate debt is not a recurring practice, that it is done to provide relief and enable a change in financial habits.
If you would like to run through your numbers to see if you may benefit from a debt consolidation please give me a call and we can discuss your situation. Often the conclusion that is reached is we do not need to refinance, but by restructuring your spending habits and how you are paying your debt you may be able to achieve debt relief without increasing your mortgage.
Have a question? Ask me!
Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.
Continued mixed data on the economy. Reports for economic activity in May reflect the mixed data of prior months. Consumer confidence almost reached a sixteen year high in May, mostly on expectations for income and jobs. That should be reflected in increased spending and economic growth when 2nd Quarter GDP data is released next month. The final revisions to 1st Quarter GDP data however does not reflect strong consumer confidence. While the final growth number was revised up to 1.4% from 1.2%, the growth number is still considered not strong, bordering on weak. Within the GDP report consumer spending was upgraded, but only enough so that spending in the quarter went from the weakest in seven years to the weakest in four years.
Personal income and spending data in May did not reflect the consumer confidence data. Personal income for the month rose only 0.4%, but wages and salaries only increased 0.1% from April and transfers were the bulk of the general increase in income. Spending matched wages, increasing only 0.1% from April. One constant in the report over the past several months has been personal savings, which rose 0.4% in May and is at a very high 5.5% of personal income.
Overall the data is somewhat positive for rates. While the slight revision to GDP could push rates higher, the personal spending and wages are a drag on the economy and creates a soft rate environment. There will be a lot of attention on the 2nd Quarter GDP numbers to see if increasing consumer confidence pushed the economy higher—if so we can expect upward pressure on rates.
Rates for Friday June 30, 2017: Last week it appeared that rates would break down with any soft economic data. We got the soft data but rates did not break down, late in the week we saw rates strengthening on technical issues. The end result is another week with no change from the previous Friday.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS LOCKED FOR 45 DAYS:
30 year conforming 3.75% Flat
30 year high-balance conforming 3.875% Flat
30 year FHA 3.25% Flat
30 year FHA high-balance 3.75% Flat
Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, no impound account and period rate is locked. Rates are based on 20% down (3.5% for FHA) with 740 FICO score for purchase mortgages.
I hope everyone has a wonderful Independence Day celebration. My favorite holiday, not necessarily for the fireworks, hot dogs and get togethers, but for why we celebrate. Enjoy your freedoms and give thanks for those with the courage and resolve to declare the “united Colonies are, and of Right ought to be Free and Independent States…”
If you are replacing your flag as part of your celebration, or know someone who is, see below about our Annual Flag Collection and Retirement Ceremony next Friday July 7th.
Have a great week,
Next week, on Friday July 7th, we will be having our Annual Flag Collection and Retirement Ceremony in Bixby Knolls as part of the monthly First Friday event. If you have a flag that needs retiring please bring it and we will collect and give to the Boy Scouts for proper disposal. We will be at Georgie’s Place, 3850 Atlantic Avenue, Long Beach at 6:00 and at 7:30 the Boy Scouts will conduct an official retirement ceremony of a flag. A great event if you have never witnessed a retirement ceremony.