Weekly Rate & Market Update 7-15-16
Question of the week: Does it make sense to pull money out of my home to pay off other debt?
Answer: This question is now the third in a series of Questions of the Week on refinancing. First the question was whether to pull out cash from home now for use later, last week was simply should we refinance, now whether to refinance and pull out equity to pay off other debt.
This is a common question and the most frequent target for the “other debt” being paid off is a HELOC, or Home Equity Line of Credit, that is a lien against the home and has an adjustable rate.
Other debt that some consider paying off with cash out of their home is consumer debt, i.e. credit cards, student loans, auto loans.
When answering this question with clients the questions we need answered are:
- What is current value of the home?
- What is your current mortgage balance and rate?
- What is the total amount and nature of the debt?
- What is your current interest rate?
- What is the total of payments that go along with the debt being paid off?
Some mortgage basics. Typically when analyzing the cash out scenario we are looking at conforming mortgages, either a Fannie Mae or Freddie Mac product, although there have been times when using a FHA or VA product is suitable. As you are probably aware for most of Southern California the conforming loan limits are $417,000 for the basic conforming mortgage and $625,500 for “high-balance” mortgages.
The $417,000 limit is important as when a cash out mortgage goes over that limit and into the high-balance range then the maximum loan to value is lower and the costs for pulling cash out are significantly higher.
Once we have they type of mortgage determined then we consider the nature of the debt we are paying off and start doing math.
If you have a HELOC on your property and wish to pay it off the transaction is considered to be cash out unless the HELOC was used to purchase the property and you have not accessed the credit line in the last 12 months the refinance is considered a rate and term refinance, which is generally lower cost/rate than cash out.
This math can be pretty easy. You have $375,000 mortgage with rate of 4.25% and a HELOC with balance of $40,000 at Prime + 1% (3.5% + 1% = 4.5%) with combined payments of $2120 per month, you have opportunity to refinance at 3.75% a $415,000 balance with a payment of $1920 per month you refinance and save $200 per month plus lock in the rate of your equity line.
What if the debt you want to pay off is credit cards?
This changes the conversation. While the math may make sense to consolidate your debt and reduce your monthly debt payments, the bigger question is whether it is a good idea to use your home to finance consumer spending. This scenario is one that came back and hurt many homeowners after the bubble who on more than one occasion found themselves with very high consumer debt and since rates were low and their home value had increased significantly refinanced and pulled cash out to pay off their consumer spending.
If you are going to refinance and use equity in your home to pay off consumer debt, and have that debt be paid off over 30 years as a result, it is important that your plan of action moving forward include two key components: First, reduce your spending and do not use credit, or nearly as much, in the future. If you do not then you will find yourself in a similar position not too far in the future where your credit card debt is hard to manage and you are looking for a way to make it manageable. Second, use the savings from the refinance to build up your savings/reserves and/or pay down your new mortgage until the balance is down to your original loan balance when you refinanced, then either keep paying down or put the money into savings/ reserves (at that point you will already have accelerated the paydown and your mortgage term will have decreased from the 30 year term).
Example: You have mortgage with balance of $375,000 with a payment of $2000 per month and credit cards of $40,000 with a minimum payment of $800 per month for total payments of $2800 per month—and you are just paying the minimum on the credit cards.
Your refinance for $415,000 at 3.75% for a payment of $1920 per month you are reduce your total debt payments by $880 per month.
If you make the same total payment per month as you were before with your mortgage and credit cards of $2800 per month on your new mortgage in two years you will have paid off the credit card debt, your mortgage balance will be approximately $375,000 per month. If you continue on that payment schedule your mortgage will be paid off in about seventeen years. Or as mentioned, you can then reduce your mortgage payment to the required amount of $1920 per month and put the additional $880 into your savings/reserves.
While it may be a great time to refinance and obtain some equity to pay off debt, whether it is a good thing to do or not depends on your actions and habits moving forward. Make sure you have a plan and follow that plan.
If you are interested in paying down debt but not using your home to do so I have a method that has worked for many clients over the years I will share with you next week.
Remember, with Dennis it’s not just a mortgage, it’s your complete financial picture.
It has been awhile, but we have a week with all positive economic news. Prices for wholesalers (the Producer’s Price Index) and consumers (the Consumer’s Price Index) both showed nice gains in June, as did Retail Sales. Rising 0.5% in June, wholesale prices pushed the year over year price gains into positive territory and pressures consumer prices to rise in the future. On the consumer side CPI increases in June matched those in May, growing 0.2%.While still tame and below the Fed target, consumer inflation is steady and ready to accept price increases from down the chain as wholesalers increase costs to retailers. This combined news pushes rates higher.
Speaking of retailers, out of school sales must have been busy as consumer spending on retail items increased 0.6% in June. A small downer in the report was a revision downward for May sales, but the revised number was still growth in sales from April. Most consumer spending is good for the economy since it consists of 65-70% of our economy, and since it is good for the economy it means it creates upward pressure on mortgage rates.
Rates for Friday July 15, 2016: After Mortgage Backed Securities have been riding at the high end of the trading range for some time it is not a surprise that positive economic news pushes the prices down, and therefore rates up. Whether this is long term correction that leads to trending higher rates, or if it is short term profit taking, won’t be known for a week or so. In the meantime I continue my advice of locking through your escrow period as soon as you are able. After hanging onto the bottom of the rates graph for a few weeks rates tick up this Friday.
FIXED RATE MORTGAGES AT COST OF 1.25 POINTS
30 year conforming 3.375% Up 0.125%
30 year high-balance conforming 3.625% Up 0.125%
30 year FHA 3.00% *** Flat
30 year FHA high-balance 3.25% *** 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. ***FHA rates have may have no points and credit towards closing costs, changes daily.
With our girls safely packed off to camp for several weeks, Leslie and I are going to meander around California starting up the coast and Highway 1. We have spent tens of thousands of miles driving the highways and by-ways of the United States but have never had a prolonged drive just within our beautiful state. Looking forward to the small towns, diners and stores and meeting the great people who are part of them all.
Have a great week,
Dennis
