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Consolidating Debt - Refinance or Second Mortgage

Consolidating Debt - Refinance or 2nd Mortgage? - Homeowners who need to consolidate their high interest unsecured debts often wonder what is the best way of doing it. Is it best to refinance your first mortgage or take out a second mortgage or Home Equity Line of Credit?

Recent increases in the Prime Rate have made the Home Equity Lines of Credit much less attractive than they were a few years ago.

Taking advantage of refinance programs which allow you to consolidate your debts and modify the rate and term of your first mortgage, such as adding a minimum payment option, can allow you to really boost your cashflow or focus your finances. We have had customers who were paying 2500 a month in mortgage + credit card & car payments drop down to making one minimum payment of 1100 dollars a month after debt consolidation refinancing. In the same situation, a second mortgage would have only reduced their total monthly spending to 2150 a month.

A good mortgage broker can work out a cost analysis breakdown for you to show you the pros and cons of refinancing your first mortgage to consolidate your debt versus taking out a second mortgage or home equity line of credit to consolidate your debt. One advantage of a home equity line of credit is that many times you can obtain one without any closing costs at all. In the right situations this can be very beneficial to a consumer instead of paying the closing costs on a first mortgage, especially if there is any chance of not keeping the loan very long or moving.

Typically home equity lines of credit are reported as revolving debt if the loan amount is under $50,000.00 (check with your local lender guidelines). Most home equity lines of credit are also interest only payments that adjust on a monthly basis which may make things even more difficult for a homeowner over the long run.

In that case, refinancing your debts into one mortgage may make more sense than obtaining a high interest, fixed rate second mortgage or a home equity line of credit.

Often you can get a lower combined rate and a lower payment by refinancing your mortgage instead of getting a 2nd mortgage or a home equity line of credit. Your mortgage professional can make these calculations for you.

One thing to watch out for. Many home equity lines of credit will report on the borrower's credit report as revolving debt rather than mortgage debt. This can often cause a substancial detriment to a borrower's credit score. Feel free to call me and I can help you determine how your HELOC is reporting. If it is reporting as revolving account, you should insist that the lender report it differently or refinance out of it.

In today's rising rate environment, Home Equity Loans, Lines of Credit and other short term interest rate-linked forms of financing are increasingly risky liabilities to have on your creditand your home. Consider consolidating all of your revolving and secondary debts into a single loan.

Don't use a home equity loan as a way to manage your outstanding debt. Instead, use it as a way to eliminate your debt entirely. Find a good mortgage broker that will show you how to use your monthly savings to pay off all of your debt, including your mortgage, in a much shorter period of time.

Debt Consolidation Refinance - Doing a debt consolidation refinance is a very common type of refinance and is one of many reasons to refinance your home mortgage loan. Consolidating debt into your mortgage has numerous benefits. One such benefit of refinancing your debt into your mortgage is that you are generally able to save quite a bit of money each month through the consolidation. A quick example to show you how you can save a lot of money is as follows:
Lets say you are currently paying a 7% interest rate on your mortgage with a balance of 100,000 dollars. Your monthly mortgage payment is $800. You also have 5 credit cards with a total balance of 20,000 and a total of $750 of minimum monthly payments. This gives you total monthly expenses of $1,550 ($800 mortgage payment + $750 credit card payments). By consolidating these into your mortgage at the same 7% interest rate your new total monthly mortgage payment on a 120,000 loan ($100,000 mortgage balance + $20,000 credit card debt) might be $1,000. Therefore, you would have eliminated all of your credit card debt and credit card payments and you will have also saved $550 from your total monthly expenditures ($1,550 total monthly payments - $1,000 new mortgage payment). Consult your mortgage professional to find out how you can start saving money immediately.

One of the greatest risks of relying heavily on credit cards is assuming that only high interest cards can be damaging to your credit. In fact some of the most damaging accounts you can have on your credit report are the 0% interest cards and accounts opened popularly by department, furniture and electronics stores. You've seen it before, no payments for 1 year. Sounds great right? What they don't tell you is that the $10,000 HDTV setup shows up as a $10,000 balance on a $10,000 limit credit account (which will drop your scores dramatically as soon as it's opened) and then you make no payments for 1 full year, so there is no payment history to get those points back. While you will ultimately have to decide what to pay off and when, debt consolidation using home equity can afford you the opprtunity to get clean, simplified reporting and tax deductible interest on all of your outstanding debts, and is a great way to make a clean start.

A third benefit of a debt consolidation loan is that you create a better tax advantage. The interest you pay on credit cards, car loans and other consumer debt is not tax deductible. However, the interst you pay on a Home Mortgage or Home Equity Line of Credit is tax deductible. So even if you are transferring credit card or other debt with low interest rates you most likely still will come out ahead because of the tax advantage.

This type of refi can save you hundreds of dollars per month in your overall debt payments

A second benefit to a debt consolidation loan is the positive impact on your credit score if you payoff your credit cards or other accounts that have high interest rate and or a high balance. It is impossible to create a financial plan or budget when you credit payments are increasing each month. With a fixed credit payment each month, a realistic and low stress budget can be managed.

Another benefit that many people don't cosider is the improved cash-flow created by a debt consolidation refinance and the investment potential it creates. In the above scenario, you save $550 per month by consolidating your debt into your mortgage. The improved cash flow of $550 per month can be used to create more wealth by saving or investing it to get a return on that money. Putting $550 per month into a savings account for 12 months results in a balance at the end of the year of $6600. Over the 30-year term of the average mortgage, saving $550 per month means you will have accumulated $198,000 - enough to pay off that debt consolidation refinance of $120,000! Invest that same $550 per month with a financial advisor or other investment manager and the return on that money will be even greater.

Some people advise against paying off credit card debt with a refinance. They use arguments such as "you're going to be paying on last night's meal at a restaurant for 30 years."
However, that argument has its weaknesses.
If you pay the minimum amount on your credit card every month, you could be paying for that meal for over 20 years. And paying at credit card rates for 20 years will cost more than paying at mortgage rates for 30 years.
Also, a debt consolidation refinance can usually free up some money every month, so you can use your credit cards less in the future.

Many people acquire debt due to unforeseeable life events, such as a birth, the death of a loved one, or loss of employment. Other people accumulate debt because their income cannot support their life style. Make an effort to change the habits that incurred so much debt and keep in mind that when you consolidate credit card debt you are transferring unsecured debt to debt secured by your home.


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