| Refinancing
- Part 3 – Cash out and Debt Consolidation
Americans
are tapping the equity in their homes in record
numbers these days. This is a result, in part,
of the high equity that has built up in the highly
heated residential real estate market. In addition,
banks and other lenders are making it extraordinarily
easy to borrow these days. One bank’s advertising
has the “Equity Police” out helping people look
for unused equity. This over looks the fact that
equity in a home is actually a good thing.
There
are certainly some constructive uses of the extra
cash that can be generated by this kind of refinance,
but there are also some dangers here. Let’s be honest,
some people have less of a sense of discipline than
others and they may be tempted to take out additional
debt indiscriminately. In the case of equityline
loans, borrowers get a check book on which they
can write big checks. It can seem like free money
and can be a powerful temptation. Let’s look at
this further.
Does
it make sense to refinance to get the cash? I have
to admit that I tapped some of the equity in my
home to pay tuition when I had two kids in college
at the same time. However, financing an education
with a 30-year loan doesn’t make sense. The same
thing can be said of buying a car with the added
cash or doing a debt consolidation loan, paying
off high interest rate credit card balances.
If
you have a non-optimal loan and are considering
refinancing anyway, then it makes sense to refinance
and take out the extra cash you need. In general,
whenever you refinance and use some of the proceeds
to pay for something else, work out an amortization
table that will show you how quickly you can get
the loan balance back to its pre-purchase level.
There are many of those calculators on the Internet.
Let me give you an example.
Two
borrowers owe $200,000 at 7.5 percent so refinancing
into a new loan at 5.5 percent makes good sense.
They also want to buy a car for $30,000 and have
the interest be tax deductible. Therefore they are
considering getting a $230,000 loan. Now they certainly
don’t want to pay for a car for 30 years so they
need to adopt a higher payment schedule until that
additional $30,000 is paid off. Here are the way
those numbers work assuming that they want to pay
off the additional loan in five years.
Obligatory
payment on $230,000
$1,305.91
Payment
to pay off “car portion”
$573.03
Total
$1,878.94
They
can make that higher payment for five years and
then either revert to the obligatory payment or,
if they have become accustomed to the higher payment,
keep paying that and pay off their loan faster.
In fact, at the payment above, they really have
a 15-year loan. They might even consider just
getting a 15-year loan to begin with. This same
strategy can be employed in the other scenarios
mentioned above.
An
alternative is to get an equity lines, currently
in the 4.25 percent to 6 percent range, but adopt
the same accelerated payment plan. At the end of
five years, the equityline loan will be paid off
and still is available for other, hopefully constructive,
purposes.
The
point here is to have developed a repayment plan
before you embark on the refinancing adventure.
People who don’t do this frequently just end up
with more debt, debt that does have to be repaid,
and yet when they look around and see what they
bought with that debt, they can’t find it.
Be
careful out there!
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