Posts Tagged "mortgage payment"

Refinancing your home Part 2: An Example

Posted by Preet on Jul 27, 2007 | 2 comments

Okay let’s show how an actual couple ended up freeing $915.80/month by refinancing their home. I’ve rounded the numbers, but they are from a real life scenario. We’ll begin with a snapshot of what their financial situation was BEFORE:

Home Value: $250,000

Mortgage: $150,000 balance, 20 years left, 6% interest rate = $1,070 Monthly Payment

Credit Card Debt: $10,000 balance, 18.8% interest rate = $500 Monthly Payment

Vehicle Loan: $26,000 balance, 8% interest rate = $500 Monthly Payment

Department Store Charge Cards: $5,000 balance, 28.8% interest rate = $250 Monthly Payment

In this case, they have a total debt obligation of $191,000 and total monthly payments of $2,320.

By refinancing, they were able to take out $41,000 of equity from their house to pay out the vehicle loan, the credit cards and the department store charge cards. This increases the mortgage from $150,000 to $191,000. Plus, let’s add a $5,000 charge to break their existing mortgage for a total new mortgage balance of $196,000.

However, that entire amount is now being charged 6% interest and amortized over 20 years.  The new mortgage payment is $1,404.20. …but that’s the only payment.

So: Old Total Monthly Payment ($2,320.00) – New Total Monthly Payment ($1,404.20) =

$915.80 Saved Per Month

Take this with a grain of salt.  You have to factor in the trade-offs. Yes, you free up a lot of money monthly, but it has to be put to good and productive use. Also, before they would have freed up the $500 monthly vehicle loan payment in 4 years anyways, but now they blended it into a 20 year mortgage, effectively paying for that vehicle for 20 years. In many cases, these trade-offs are more than acceptable to people who are looking into refinancing as they are in dire need of a short term solution and even just a little breathing room is enough of a dangling carrot for them to proceed. In this particular case, a $915.80 monthly savings was very compelling and they are currently saving $700/month out of that into an investment account.

Refinancing your home

Posted by Preet on Jul 27, 2007 | 0 comments

I’m going to offer up an example in a following post, but this post is to deal with the psychological aspect of refinancing your home to consolidate debt.

First, let’s just make sure we’re on the same page and define “refinancing your home”. This is basically when you have some equity built up in your house (after paying your mortgage payment for a few years or having put a large down payment on it) and you use that equity to pay off OTHER debts so that instead of having a mortgage payment, a credit card payment, a line of credit payment, a vehicle payment, etc you will only have one slightly larger mortgage payment and that’s it. I say slightly because you have taken all the other debt payments and in effect turned them into debts with longer repayment time lines, thereby reducing how much you pay monthly. So why do people want to do this? Cash flow – plain and simple. People can free up $1000/month in some cases which can be used for building up an emergency reserve, long term savings, and in many cases allows them to just breathe easier. (Refer to my upcoming post using a real life example with hard numbers.)

When you refinance you will generally reduce the overall amount of interest you are being charged on all of your debts as well. For example some credit cards are charging 19.9% per year, and department store cards are sometimes charging 28.8%. Once you refinance that debt into your mortgage you get a lower interest rate since the debt is now SECURED (by your home) as opposed to UNSECURED. Secured means that you basically agree that if you can’t pay your debts, the bank will get the value by selling your home, taking what you owe them and leaving you with the rest. Since the bank has a better chance of getting their value back when you secure your debt, they will lower the interest rate to reflect their reduced risk.

So the equity in the house is the total value of the house MINUS your mortgage balance. Example: you bought a $200,000 home and put $50,000 as a down payment.  That would leave you with a $150,000 mortgage. Your equity would be $50,000. After a few years, you’ve paid some principal and interest back in the form of your mortgage payments and now maybe the mortgage balance is $135,000. PLUS maybe the value of the house has gone up to $235,000. At this point the value of the house ($235,000) minus the mortgage balance ($135,000) leaves you with $100,000 of equity.

One reason refinancing has become so popular is that housing prices have really appreciated, in fact we are in the longest housing bull market in history. This has created a lot of equity, and to refinance to clear up debt and reduce the overall cost of borrowing is a sound strategy (until you look at the psychological aspect of it.)

People are doing this en masse these days as people are perpetually spending more than they earn.  Why do people put so many purchases on credit? Well, these days one of the main reasons have been the incredibly low interest rates – it makes the carrying cost seem very reasonable – and people became used to using credit, hence: they have a lot of debt!

So the only real problem of refinancing your home to consolidate debt? If you don’t correct the spending habits that created the situation in the first place you will start spending your new found cash flow similarly to before and end up even further behind within a few years. I’ve seen it happen and the next step will be bankruptcy! So make sure you can adjust your habits.  Use a financial advisor, set up a forced savings plan with the new money and stick to it!