Credit Card Debt Consolidation

Credit cards can take many years to pay off and a lot of extra money in interest. A homeowner can not only save money by combining these into their mortgage, but they will also then be able to claim the interest on their taxes. A person is not able to write off the interest that they pay on credit cards, student loans, car loans or personal loans as a deduction on their taxes. Once the homeowner refinances and consolidates the payments into their mortgage, they are then able to write that extra interest that they are paying off as a deduction on their yearly taxes. This can help the homeowner get a larger tax refund or keep them from owing more in taxes at the end of the year.

Extending Mortgage Payment Terms

Some people that refinance back into a 30 year mortgage don’t want to consolidate their other debts into their mortgage and take 30 years to pay it off. But, the homeowner should not just look at the negative part of it maybe taking a longer period to pay the other loan with mortgage refinance. A car loan that they originally took out for 4 or 5 years would be paid in that time, but the interest that they pay on that car loan is not tax deductible. A debt consolidation refinance is also a very good way for a homeowner to reduce their monthly bills. A person that has accumulated many debts or going through a divorce may not be able to afford their monthly mortgage payment and in jeopardy of losing their house. Consolidating their debts may help to reduce a lot of stress, save hundreds of dollars every month and allow a homeowner to keep their home.

A person that has been paying off their mortgage for 10 or more years may not want to refinance back into a 30 year mortgage, but still wants to combine their debts so that they are tax deductible. A great option for this homeowner would be to refinance into a 10 or 15 year mortgage so that they are not adding all of those years back onto their mortgage. Their monthly mortgage payment might go up some since they are not only increasing the balance with debts and shortening the term on their mortgage, but they will be able to pay off their mortgage in the same or shorter amount of time.

Home Equity Required

A debt consolidation refinance does require a homeowner to have the available equity in their home to be able to add in the debts to their mortgage. A homeowner also needs to have good credit, enough income and no late payments on their mortgage in order to qualify for the refinance. These things are necessary to take into consideration before a homeowner decides to start the refinance process and find out that they will not qualify.

The building of equity in your home coupled with the building of consumer debt will undoubtedly lead you to consider the benefits of consolidating your debt by refinancing your home. A debt consolidation refinance loan can be helpful to many, though it is not the solution for everyone. You should first evaluate your financial objectives before making the decision.

To help with your decision, you should first be aware of the benefits of debt consolidation refinance.

Reduce Interest Rates

Most likely your credit cards and other loans have a higher interest rate than your mortgage. By rolling this debt into your mortgage loan you will reduce your overall interest rate on your total debt. Also, depending upon your existing mortgage interest rate and the current market, you may be able to reduce the current interest rate on your home.

Deal with Pressing Credit Issues

If you are to the point that you are getting or are about to receive harassing phone calls, consolidating debt can make those calls disappear. Using the equity you have built up in your home to satisfy immediate issues with creditors is a distinct benefit of mortgage refinance to consolidate debt.

Debt consolidation home refinance can help to keep your credit score from heading south. Being late or missing monthly payments can seriously damage your credit score. Rolling your debts into one loan will pay off these creditors and restore your credit so you may qualify for lower rates in the future.

Reduce Monthly Payments and Improve Cash Flow

A debt consolidation refinance loan will improve immediate cash flow problems. You will be able to get cash out of the loan to pay off outstanding debts. Also, the reduction in total monthly payments will leave more money left over after each paycheck. However, it is recommended that you use that excess cash from each paycheck to pay down your loan in order to reduce interest payments.

Convenience of Paying Bills

Trying to keep track of several credit cards, your mortgage, car payments, personal loans and other monthly bills can result in late or missed payments. Missed payments can cause an increase in interest rates on credit cards on top of late fees and a lowered credit score. Consolidating your credit cards and other loans into your mortgage reduces the amount of checks you have to write and the due dates you must keep in your head.

Debt Consolidation Refinance the Right Way

Choosing to consolidate debt by way of refinancing your mortgage can be beneficial, but it is not for everyone. It should be done properly. It is easy to fall into a lifestyle of living beyond your means and finding yourself every few years in a precarious financial position.

In order to make the right decision, you must first consider the long-term implications rolling existing debt into your mortgage. While you will be settling short-term debt, that debt will become a part of your 15 or 30 year mortgage. Credit card debt that you could pay off in five to ten years will be stretched out to the life of your mortgage, meaning the possibility of more interest being paid overall.

To avoid paying more interest over the life of the debt, adhere to the following guidelines. They will make debt consolidation refinance work for you.

• Avoid building another mountain of debt by living beyond your means.

• Do not get involved in the cycle of refinancing your home every two to three years to pay down credit card, personal loan and car loans.

• Pay more than your monthly payment to reduce the overall interest charges and reduce your overall debt.

Debt Consolidation Benefits Should Outweigh the Pitfalls

The decision to refinance your mortgage in order to consolidate debt should be made according to your specific situation. There are many benefits you can receive by refinancing to consolidate debt, but there are also pitfalls. You must be able to reap immediate and/or long-term benefits while avoiding habitual pitfalls.

Mortgage rates are expected to rise in 2010, so get in early to take advantage of the still low mortgage refinance rates. If you can reduce interest rates, protect your credit, increase cash flow and find convenience in paying bills without resorting to old habits, then debt consolidation refinance could be incredibly beneficial for you.

Let’s say John and Jenny have a $300,000 loan on a home that they bought in 1998, and comparable properties in the neighborhood are now selling for $600,000. This is 300,000 in equity.

Since John and Jenny lke to live beyond their means they’ve also got $15,000 in consumer credit, a $10,000 home improvement loan, and two new SUVs with associated debt of $20,000 and $30,000. These are fairly typical numbers.

John and Jenny’s mortgage payments are currently $1720 per month, because they refinanced to 5.25% in 2003 when the rates hit bottom. Their monthly payments on the credit cards are $400. The payments on the SUVs are $500 and $600 per month, respectively. The payment on their $10,000 home improvement loan for landscaping is maybe $150. Arnie and Annie are forking out $3370 per month without taking into account stuff like property taxes, insurance, utilities, etcetera. It’s really cramping their lifestyle.

Suppose they consolidate these loans into one payment on a thirty year home loan? So it costs them anywhere from zero to $20,000 to get the loan done. Let’s split the difference and say $10,000. That’s about two points plus closing costs.

This adds up to a $385,000 loan. With a 30 day lock, that would have gotten you 5.775% or close. The new payment: $2177. Voila! Despite the higher interest rate, Arnie and Annie are saving almost $1200 per month!

Or are they? On the credit cards, their monthly interest was $225; their $400 payment would have paid the cards off in less than five years. The interest on the SUVs was $333 total on the two, and their payments would have had them done in about five years. The home improvement was a ten year loan but even so their monthly interest was only $75. Now these are all thirty year debts. The monthly interest on their old home loan was $1312. The interest charges on their home loan is now $1884, where total interest was $1945 previously. So they are actually saving money on interest.

The difference is that now they’re not paying the old loans off as fast - they’ve spread the principal over thirty years. In the meantime, the bank is getting all this lovely money in the form of interest from them, and if they refinance about every two years as most people seem to do, this is $85,000 more that they owe on their home, and that John and Jenny will pay points and fees on every time they refinance! Meanwhile, John and Jenny are quite often out charging up more debt they’ll consolidate into their home loan, and they’ll keep doing this trick for as long as they can.

Let’s assume John and Jenny beat the odds and don’t refinance for five full years. This puts them ahead of 95 percent of the people out there. Let’s look at where they’ll be five years out if they make the minimum payment. They will owe $357,700 on their home. On the plus side, they will have had $66,000 to spend on other things (and they likely will, if they are typical Americans). Total debt: $357,700.

If they had continued making their previous payments, they would now owe $272,100. Plus they would be done with the SUV’s and the credit cards and would only owe $6600 on the home improvement loan which they could now concentrate on. Total debts: 278,700.

Net difference: $79,000. Subtract that $66,000 they had real good time with (and nothing to show for), and they’re still $13,000 in the hole.

They do have a $572 per month potential additional deduction, assuming they are willing to risk the wrath of the IRS. Assuming they are in the 28% tax bracket and get to deduct the full amount, that gives them $9,600 less that they owe the government in taxes. Net amount John and Jenny are out are out: $3400, in addition to being set up for higher fees on future loans, and having a loan balance $77,100 higher. Additional interest they will pay because of the higher balance if they can get a loan at 5 percent even: $3855 per year.

Sounds like an awful bargain doesn’t it? Many consumers have done this three and four times, or more. I run across people who bought their home in the early 1970s, and have mortgage balances ten to twelve times the original purchase price.

Now, suppose instead of milking our equity for cash flow, where we’re trying to minimize our monthly payments, we do it differently. Same situation, same numbers, but instead of spending that $993 per month, we use it to pay down our mortgage.

Actually, let’s pay $3300 per month, so we still have $70 per month to spend elsewhere. After five years, we still owe $286,600. We got $4200 to spend elsewhere. And all of our other debts are gone. In addition, we got that $9600 in tax reductions. Net amount to us: $5800, although we still owe $8000 more, and if we get a 7% loan, that’ll cost us $560 per year. Notice that at this point, the benefits, while tangible, are still fairly small. Furthermore, if we refinanced or sold before this point, as ninety-five percent of everyone does, any benefit we may have gotten in the future disappear.

But: If we keep making that $3300 payment after those five years, and don’t roll anything more into the loan, then the mortgage is paid off and we are debt free - the house is paid off, and the other debts are history - in less than ten more years! Now this relies upon us being thrifty and keeping those old SUV’s going and not charging up any more credit and not doing anything else to make the debt worse. In short, not giving in to the marketing culture. Many people say they don’t. Few actually manage it.

So you see, even if you do it right, it takes years to show the benefits of this kind of refinance. This is years of doing something that they do not have to that most folks just won’t do. If you have an unsustainable cash flow situation, by all means you’ve got to do something about it, but don’t kid yourself that it’s financially fantastic. On the other hand, if you’re one of those who have to ability to make the scenario in the last paragraph (or something like it) happen, it’s well worth doing.

Now this hypothesis is highly sensitive to initial assumptions. I previously assumed that John and Jenny are and always have been top of the line borrowers, able to qualify for anything. Suppose they weren’t? Suppose they were in a C grade loan at 7.25%, but now they qualify A paper at 5.875. With a payment of $2070 per month formerly, of which $1812 was interest, the new loan saves them $1450 per month in minimum payments and $561 in actual interest while still saving about $1209 on their taxes over five years. You’d have owed $288,000 on the old program, now even if you put in only the same $3300 per month in payments, you’re $1400 ahead of where you would have been on the balance, and you still had about $400 per month to spend. On the other hand, if John and Jenny were A paper but now they are applying for a C grade loan, it cannot be justified on anything except “the cash flow keeps us out of bankruptcy!” because it’s financial disaster.

Some alert people will have noticed I didn’t explicitly include the $10,000 cost of the loan in the computations of whether you’re better off. That’s because it is gone, sunk, included in the computations of where you ended up. It was part of your initial loan balance if you did it, included in the ending balance, and therefore included in the computations of whether you were better off. Now, if the cost of doing the loan were lower, there would be somewhat larger benefits a little bit faster, and indeed a lower cost loan is probably a better idea for most people, even though it means the rate and payment will be slightly higher. See my article on Why You Should Ignore APR for more.

The important thing to remember is to not get distracted by the fact that your minimum monthly payment goes down, and see if you (and your prospective loan officer) can come up with a loan and a plan that really makes you better off down the line, instead of one that sucks the life out of you financially, like the vast majority of these scenarios do.