4 Ways To Consolidate Debt Using Real Estate:
1. Selling & Purchasing a New Home
2. Cash-out Refinance
3. HELOC
4. A Second Mortgage
Dear Friends,
Allow me to begin by saying, that I’m all for equity, and equity in Real Estate goes a long way to having peace of mind, not to mention a more comfortable retirement. On the other hand, in my 20 years
of mortgage lending, I have encountered many homeowners who have benefited greatly
by consolidating their higher interest rate debt, into one, easier to manage, lower rate,
tax-deductible mortgage payment. There are multiple ways to do this, but using your home as
a way to consolidate other bills isn’t always advantageous. This blog will discuss the disadvantages
and advantages of debt consolidation, and the four different ways of using mortgage financing to do this.
Debt Consolidation Disadvantages:
The trap that one can run into is wanting to use their home as an income source, rather than a savings account. Repeated Cash-Out mortgages, or repeated increases in Home Equity Loan Balances that are intended to pay off consumer debt, can eventually have negative consequences. Over time, heavy consumer debt can get charged up again and again, and the final mortgage balance(s) one can end up with may be much greater than when they first bought their home. In the end, the homeowner can end up with the same amount of consumer debt that they started with years ago, but with much more owed on their home, and with a much higher mortgage payment(s).
Thankfully, as a nation, we as homeowners have seemed to be much more cautious in guarding against this trend than we were in the 1990’s, and all the way into 2006, which in part, eventually lead to the 2007-2008 housing bubble. Fast forward to February 2018, with the rapid appreciation we see in today’s housing market, these same temptations to over borrow may resurface. Let’s remember that it is important not to use your home as a debt consolidation instrument over and over again. Beware, there are some lenders out there that may try and convince you otherwise. In mortgage lending, this is called “churning,” and when done intentionally, it can be a form of predatory lending. So, be on guard as the marketing for home equity lending, and cash-out refinance lending is definitely on the rise.
Debt Consolidation Advantages:
If one was to compare most consumer debt (especially credit card debt) with mortgage debt, they would find that the interest rates they would pay for interest on a home mortgage is usually much lower. Additionally, the interest you pay on your home is usually tax deductible, whereas interest paid on most other debt typically is not. For Example, if one was to trade $40,000 of combined student loans, credit cards and personal loans averaging 9% into a 4.00% mortgage rate, they would save 5% per year on $40,000 by consolidating. The savings in this example would be $2,000 per year, but actually, even more when adjusting for their mortgage interest being tax deductible.
4 Ways to Consolidate Debt Using Real Estate:
1. Traditional Cash-Out Refinance:
This would be getting a brand new first mortgage loan that pays off your current first mortgage. The new mortgage would have a higher loan amount than what is paid off, and the difference goes back to the homeowner as cash back or “Cash-Out.” This can be as effective as the above example, when higher interest consumer loans can be paid off with a lower, tax deductible mortgage interest rate. With Cash-out refinances, many people have been able to: (1) lower their mortgage rate, (2) eliminate their PMI, and (3) have received enough cash-out to pay off higher interest rate credit card debt that they just haven’t been able to knock a large dent in. However, starting the year out in 2018, we are seeing an up tick in interest rates. As of February 2018, most interest rate offers will be higher than what the homeowner already has. Judging by most of the predictions for future interest rates, we may not see much refinance activity in the foreseeable future. Likewise, “Cash-Out” refinances would not be recommended if the homeowner were to have to trade a interest rate for a higher interest rate, in order to receive their Cash-out.
2. HELOC:
A Home Equity Line of Credit (HELOC). This is an open ended, revolving loan against your home, and it will be attached as lien on your property. Since it is a lien, it will have to be paid in full when you sell your home. The process to get approved for a HELOC should be quicker and easier than it is for a first mortgage. The fees for a HELOC are very minimal, and many banks/credit unions don’t charge fees for HELOC’s at all. The interest rates are often quite low on HELOC’s, but they are usually adjustable rates. A HELOC can be charged up, paid down, charged up, paid down again, and so on… A HELOC essentially operates like a credit card would, except that it is secured against your home. Because HELOC’s are secured against your home, the interest paid on them are also usually tax deductible. The payment arrangements are very easy, but not much is applied to principal unless one is to make additional principal payments. As of February 2018, a HELOC would serve most homeowners better than a traditional Cash-out refinance, because the rates for first mortgage, Cash-out refinances are moving higher than HELOC rates. A first mortgage would also have considerably more fees than a HELOC. Typically, the bank or credit union you do most of your business with would be a good place to check first with on HELOC terms.
3. A Second Mortgage:
Similar to a HELOC, A second mortgage or a second lien will be placed on your home, so they are also usually tax deductible. The main difference is that the second mortgage is usually structured as an installment loan. That is, when you are to borrow a specific sum of money, at a specific (usually) fixed interest rate, and have a set, structured payment to make until the loan is paid in full. You cannot re-borrow after you pay down the second mortgage as you can with a Home Equity Line of Credit (HELOC). Because the rates are usually fixed, they will tend to be higher than the rates for HELOC’s, and there might be some fees involved with a second mortgage, that there wouldn’t apply with a HELOC. Like the HELOC, you would be best served by looking to your bank or credit union for this type of financing.
4. Selling your Current Home and Purchasing a New Home:
This is an interesting concept, but sometimes also a very effective way to consolidate debt. And oh by the way, also providing the opportunity to move up to the dream home that you have been wanting to for the past few years. Many homeowners don’t realize the amount of equity they are sitting on at this point in time. Many are shocked to know how much they could sell their home for in our current housing market. It is not exaggerating to say that many can sell their present home, put 20% down on their new home, and have plenty of money left over to pay off credit cards, car loans, student loans, etc. We know this, because we have worked with customers who have been able to achieve this, and we are in the midst of working with other customers who will be able to achieve this. Even for those who don’t have enough to put 20% down and be able to pay off most or all of their consumer debt with the proceeds of their home; they can still put 10% down, or 5% down with conventional financing, or even finance VA, FHA or RD. Keep in mind, you can eliminate your PMI after you can show 20% equity in your home.
To illustrate, let’s say you purchased your first home with a low down payment, FHA mortgage in 2011 for $120,000. It would not be unrealistic to think that your home could sell for $180,000 today, and perhaps even more? In this example, you may owe less than $110,000 even with the cost of selling your net proceeds from sale which might be in excess of $60,000. Maybe you use $20,000 of this to cover a 5% down conventional loan and closing costs on a new home purchase of $30,000. That still leaves this second time home buyer another $40,000 to pay off student loans, credit cards, etc. Indeed, we are seeing people take advantage of this current housing market for this purpose. Those that have been able to pay off all of their creditors, are now living life with just one payment – a house payment. Now that’s sleeping well at night! While their house payment may have went up $700 – $800, they were able to eliminate over $1,000 per month in higher interest, non-tax deductible interest payments. Furthermore, they have been able to move up to that second home they have been considering, and lock in their fixed interest rate while they are still in the 4%’s.
They say cash is King. Perhaps Equity is Queen? Okay…that’s a bad pun…sorry. But let’s face it, not everyone in the financial position they would like to be at this point in time. According to statistical data, the majority of American’s have most of their savings in their homes and retirement accounts. Fortunately, for those home owners who have purchased homes prior to 2016, they have already seen a nice pop in equity. This equity can be used to help get you get closer to the financial position you are striving for. Your equity can be used by either obtaining some type of debt consolidation loan, or by selling and buying up, and paying off consumer debt in the process! On average, we are not seeing nearly the same leveraging of credit card debt as we saw in prior decades. Today, we see more student loan debt relative to credit card debt. This tells me that those who are inclined to use an equity loan to pay off student loans, or trade up to a new home, might be more inclined to keep their debt load at a low, and manageable level after consolidation. As a Loan Officer of 30 years, who has lived and worked through many housing markets, I can say with every confidence that if you are looking to accomplish debt consolidation by one of these methods, it may in fact be beneficial for you. Just don’t continue to look to do it more than once if at all possible. Long Term, protect your equity!
For my past client’s and their referrals, and for Realtor’s and their referrals, I am easy to reach, very accessible, and easy to work with. I am always happy to provide the information you are looking for. Please feel free to reach out to me if you want to explore options. Maybe you are curious as to what payments might be on that house you’ve been eyeing listed at $289,900? You’ll always get honest, objective advice from me, advice that will be in YOUR best interest. As I have advised 100’s and 100’s of times in the past, “you would not benefit to refinance, but continue the great job you are already doing with regard to your debt obligations, and paying down on your mortgage.”
-Naomi Schroeder, Mortgage Lender
Phone: 877.906.4480