Should i Refinance

Riding Out the Storm

The economic news as of late has been more than dismal, it has put the “ug” in ugly. With house prices taking a kick to the shins, it is no wonder so many people are taking a “wait and see” approach before refinancing or purchasing a home. Unfortunately, that approach, which smacks of a deer caught in headlights, can be potentially damaging to one’s overall financial survivability. The good news is if you have equity in your home, you also have the capability to ride out the storm.

“What?! Refinance my home in this market?” you say. Yes. Let me tell you why. First, equity is not really your equity until you pay a lender for the privilege of accessing it. Second, equity is unutilized money that can go a long way to eliminate “bad” debt (like credit cards), and sometimes with tax benefits to boot. Third, there are many conservative ways to access equity now without putting you in hock later. Following are a few.

Most lenders lend up to 90% LTV. That means if you own a house with a market value of $250,000, then 90% is $225,000. If you only owe $198,000 on your mortgage, you have $27,000 just sitting around doing nothing. Now take a look at your other debts: credit cards, car loans, the money you owe Uncle Frank. You are making a monthly payment on these debts, usually at higher interest rates and montly payments, and with no potential tax benefits. When you refinance your home, you utilize that equity to pay down or pay off those debts, thus freeing up money through lower monthly payments AND you still have at least a 10% equity cushion left in your home.

Here is an example: (John has three debts)

CC #1 Balance: $5400 Monthly Payment: $108
CC #2 Balance: $400 Monthly Payment: $25
Car Loan Balance: $20,450 Monthly Payment: $365
Totals: $26,250 $495

Side Note: Only refinance your 1st mortgage if you are getting a much better rate than what you currently have. If not, the cost may outweigh the benefits. There are many lenders who will do a Home Equity Line of Credit (HELOC) for you at little or NO COST. A line of credit is put on your home that is tied only to its equity portion up to the 90% LTV, for our example: $27,000. It usually has a variable rate. Now don’t panic because I said “variable.” Unlike a traditional loan, you do not have to take the full amount at once; only what you need, thus only paying interest on the portion that you have used. Also, as you pay down additional principle, your payment changes accordingly. This greatly offsets any possible rise in future interest rates.

We will use a HELOC for our example. John’s debts total $26,250 with a total monthly payment of $495. He gets a HELOC for $27,000, pays off his debts for the full $26,250, leaving $750 of equity in the account. His rate is 5.75% so his monthly interest-only payment is now only $121.84. That is a savings of $373.16 a month; $4,477.92 a year. The benefits are obvious.

Another funding practice that is helping retirees is called a reverse mortgage. The loan functions similarly to an annuity in that the principle and interest are paid to the owner with the owner’s equity. These payments are given in one lump sum or through monthly payments, and the obligation to pay the lender back is deferred until the owner’s death or sale of the property. Similarly, a new “equity key” loan has just appeared on the lending horizon. Borrowers agree, in return for a payout on current equity, to share future value with the lender – a strong lending strategy since home values double every 10-12 years.

There are many sound choices home owners have to help soften the financial burdens faced today, and althoug home prices may have dropped it doesn’t mean you are out of the game. Accessing that little bit of equity now could go a long ways towards offering you peace of mind during this time of turbulent financial waters. Make your equity work for you.