Bad debt - vs - no mortgage question.

robynpaApril 29, 2008

We own our house - no mortgage - money that my grandmother left was given to us by my parents to payoff the mortgage. We live in a townhouse that was appraised last year at $155,000.

We both contribute 10% with a 3% match to our 401Ks but do not have much in liquid savings. We did have 4 months of liquid savings but my job has been affected by the credit crisis so my pay has decreased over the last 8 months by about 35% while my DHs has not increased nearly enough to make up for my loss. We had to dip into the savings a few times earlier in the year to pay bills.

We have CC debt and student loan debt. It seem to me that it would be wise to use the money in the house to pay-off the bad debt. That way when we want to move the only debt we would have would be mortgage debt but still plenty of equity in the house to use for a downpayment on a new house.

Am I thinking about this correctly? If we did decide to take this route would we go to a broker or to individual banks?

Thanks!

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lucy

I'd go to a broker who works with a major reputable bank. They are like agents in that sense and often can give you lower rates, but still work through the bank to set everything up, and your mtge will be carried by the bank, not a private person. The bank can tell you who to see.

    Bookmark   April 29, 2008 at 10:16PM
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tishtoshnm Zone 6/NM

Robyn, I think that there are several things to consider if going this route. If you get a mortgage, the interest rate is likely to be lower. However, you will most likely need to pay closing costs, thereby increasing your total debt owed. Another question I would ask myself is how long I would be extending these payments out over. There are calculators online that will show the amortization table which will give you the total amount of interest you would pay over the length of the loan. I would compare that number to what you would pay if you maintained your current loans. Bankrate.com has some pretty useful ones.

If it were me, I would probably not tap the equity of the home. In the case of a financial crisis, you can get deferments on student loans (a last resort but it is available). If I could not pay a credit card, I would not be happy about it but I would also not be worrying about foreclosure. I would probably try to build up about 3 months of living expenses again in savings and then just try to hurry and tackle the debt the best I could. I would make drastic cuts wherever possible and use the money that is not going to a house payment and just work hard to get rid of those debts. Dh and I recently took out a personal loan from Capital One to pay on our very large credit card. The interest savings were only about 1% but it gives us a finite period and we like that. That is another option to consider.

    Bookmark   April 30, 2008 at 1:29AM
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chisue

Can either of you bring in more income? Can you cut spending to the bone?

I'd be sorry to see you decrease your 401K contributions with the matching 3%, but that is an option.

If you are falling behind in CC and student loan debt at big interest rates, I hate to see you take equity out of your home. However, this small slide downhill can become a snowball.

Only you know how in hock you are, but if you can't manage the debts, rather than taking on more in the form of a mortgage, how about selling the townhome and renting for awhile?

I'm sure you don't like that idea, but if what comes in isn't covering what goes out...sometimes you have to do something drastic. It's especially hard for me to give that advice in this RE market, yet it could be your best alternative. Could you eliminate ALL your debt and rent? (You wouldn't have to rent *forever*.)

    Bookmark   April 30, 2008 at 10:48AM
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robynpa

Hi,

Thanks for your responses.

We are not going to cut back on 401K contributions. Our situation is not dire and we have cut back where possible due to my decreased income. Selling and moving to rent another place is not an option we would consider.

I guess I was just thinking about all the equity that we have in the house that it is just sitting there and that it should be put to good use. That good use would be to eliminate the bad debt and then put the $ we spend every month on the bad debt to payoff the mortgage debt.

The house is not increasing that much in value in this market. Wouldn't getting rid of bad debt all at once with a lower interest rate mortgage (that may be deductible) make sense?

Perhaps I am not informed enough to think this through clearly (I was a History major and avoid math like the plague). I should talk to a broker and get the numbers on paper to see what my options are.

    Bookmark   April 30, 2008 at 11:14AM
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jkom51

If you have access to a credit union, get a quote from them. They generally offer lower fees and competitive rates.

So obviously you have some serious CC debt if you've had to dip into savings to make payments. You do need to get that debt down, however; you also need to consider no matter which option you choose (getting a mortgage, opting for a home equity loan, or continuing as-is) you MUST factor in what you would do if your job goes bye-bye.

Whichever option you choose, you need to be certain you can survive on one income for at least six months. If you can't, then reduce one person's contribution to 401k (probably yours) and build those savings up fast. You have insufficient liquidity, and it sounds like you're just a bit too close to the edge for safety's sake.

Good luck!

    Bookmark   April 30, 2008 at 11:40AM
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harriethomeowner

If you can get a home equity loan in an amount equal to your CC debt and your payments toward that would be affordable even on one income, it seems like it would be worth it. It might not be easy to get a loan right now, though. (I mentioned on another thread that our HELOC was just cut off because the value of our house declined, and we have a solid gold credit rating. Thank goodness we weren't counting on using it anytime soon.)

There are a lot of calculators on the 'net.

Here's one for your situation.

Here is a link that might be useful: Debt consolidation calculator

    Bookmark   April 30, 2008 at 12:26PM
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dave_donhoff

Hi Robynpa,

Am I thinking about this correctly? If we did decide to take this route would we go to a broker or to individual banks?

First off, I would suggest you look at 1st position HELOC. With an equity line established you'll have the control of "peeling out" dollars ONLY when needed, and not paying interest for all of them even prior to being needed (as you would with a closed-ended loan.)

Second, 1st lien HELOCs are definitely NOT very common among retail banks... so your best bet is very likely to come from a good, well-sourced mortgage broker.

As you are discovering, squeezing too tight on avoiding costs/fees, at the risks of defaulting due to temporary insufficient liquidity, can threaten a collapse of everything (completely unecessarily.)

Luck!
Dave Donhoff
Leverage Planner

    Bookmark   April 30, 2008 at 4:56PM
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robynpa

Dave,

Can you explain further what you mean by this statment? "As you are discovering, squeezing too tight on avoiding costs/fees, at the risks of defaulting due to temporary insufficient liquidity, can threaten a collapse of everything (completely unecessarily.)"

We are not behind nor have we missed any payments and they have all been paid on time. I just paid off my car but DH has about 1 year to go on his loan.

Is it your opinion that using the equity in our home is a dumb idea and to only do it if we are unable to pay the other debt on time?

I am confused, because for some reason I feel like we would be better off financially if our cc and student loan debt was gone and we just had a mortage payment. What am I not understanding?

Also, how does one go about finding a well-sources mortgage broker?

Thanks so much!

    Bookmark   April 30, 2008 at 7:24PM
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dave_donhoff

Hi Robyn,

Can you explain further what you mean by this statment? "As you are discovering,..." yadda yadda from me...

I misread the explanation, apologies. You are in strong shape, *AND* thinking quite sharply about your equity management.

Is it your opinion that using the equity in our home is a dumb idea and to only do it if we are unable to pay the other debt on time?

Quite to the contrary! Retaining your net worth overwhelmingly in your primary residence is neither safe, nor growth oriented. If you are still building your tax-preferential retirement strategies, you most certainly would be wise to shift your equity from your real estate to other safer, more growth oriented methods.

I am confused, because for some reason I feel like we would be better off financially if our cc and student loan debt was gone and we just had a mortage payment. What am I not understanding?

A) You were accurately confused because I misread... my apologies,
B) Your student loans *MIGHT NOT* be "bad debt"... they are sometimes tax advantaged, and may have very low interest rates (or may be consolidated/refinanced to very low student loan consolidated rates.)
C) Credit card debt... yes, eliminate that... but leave the lines on the cards open, empty & alone.

Also, how does one go about finding a well-sources mortgage broker?

Well... I do be one ;~) But aside from me, you can do a web search, seek out referrals from friends, family, co-workers &/or real estate agents.

What *I* would strongly recommend, in ANY case... is to seek a Financial Planner who happens to have a lending license... rather than a vanilla Mortgage Broker.

In your case (and frankly, in most people's cases) the lowest rate in the wrongly structured overall financial picture can be far more costly than the properly designed & implemented plan overall... even if it comes at the cost of a premium planner.

Sending you all the best!
Dave Donhoff
Leverage Planner

    Bookmark   April 30, 2008 at 7:52PM
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mariend

Dave gave you some good advice. A licensed Financial Planner sounds good. Because of of real bad experiences I plan to not deal with any mortgage brokers.Sorry, my opinion only. I try to deal only with some banks and/or credit unions with fixed rates.
But you sound like you would like some advice. At this time, try not to borrow on your home, but do try to get the CC paid off, even if you have to look at a personal loan.

    Bookmark   May 1, 2008 at 1:19AM
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mnk716

I would agree with the others to reduce your 401k contributions to meet the max and use that money to pay down your cc debt.

by using the HELOC option you are just moving your debt to a lower interest rate and not getting to the meat of it which is to make big principal payments. With a HELOC or loan you will just make minimum payments for what could be 5-10 years. You are now risking your home with what used to be unsecured debt.

your cc debt interest is much higher than your 401k returns even with the match. you didnt state how much you owe but i would bet you could be paid off with in 2-3 years if you reduce your 401k contributions and make big principle payments to your debt. i would use the home as a last resort.

good luck

    Bookmark   May 1, 2008 at 11:40AM
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