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Is It in Your Best Interest?
August is upon us and change is in the air. Summer vacations are winding down while the pennant races in Major League Baseball are beginning to ramp up. But along with this seasonal ebb and flow comes change of the unwelcome variety. Rumor has it that the Federal Reserve is gearing up for its 18th straight rate hike!
The past two years have proven to be costly for the American homeowner. Between the devastation caused by some of our nation's largest natural disasters and the interest rates increases during that time, the average homeowner from coast to coast (and everywhere in between) has been hit where it counts.
The Federal Reserve's interest rate hikes have resulted in Home Equity Lines of Credit increasing a whopping 4.25%. For the homeowners who are carrying a balance on their HELOC of $50,000, they've seen their minimum payments increase $177 a month or $2,125 a year!
To make matters worse, as home values have increased over the past few years, so has the homeowner's ability to carry a larger line of credit. Today, it's not uncommon to see HELOCs in amounts of $100,000 or more, increasing not only the amount a borrower is paying in total interest but also presenting an increased drain on their monthly cash flow.
Just as Home Equity Lines of Credit are tied to the Prime Interest Rate, so are many consumer credit cards. It's very rare these days to find a card that is offered at a fixed rate of interest. Consequently, just as HELOC interest rates have risen, so have the rates on consumers' Mastercard, Visa, and Discover accounts. Throw in the increase in fuel prices, and the average homeowner could be shelling out over $1,000 more a month (with no increase in debt) than they were paying just two years ago. Even though the Federal Reserve tells us overall consumer inflation is under 5.00%, payment inflation could well be exceeding 25% for many of us.
So what's a homeowner to do? Aside from the oft prescribed "taking two aspirin", consolidating all your debt into a new first mortgage may be just what the doctor ordered.
Taking into account the record low interest rates for many fixed rate mortgages, it's understandable that a homeowner might be reluctant to refinance a mortgage that's already in the 5.50% range. Despite the appeal of a sub-6% rate for a first mortgage, what's more important is the average rate of interest you're being charged on your total debt and whether you can improve upon it. It's possible that even with a low first mortgage rate, you could be paying over 8.00% when all of your debt is combined.
The first step is to look at the interest rates on every one of your accounts. To figure out the average interest rate you are paying, take the amount you owe on each debt and multiply it by the interest rate you're being charged. Each sum is the total annual interest you will pay on the individual debt.
Now, add up all of the "annual interest" amounts and then divide this sum by the total amount owed. This will give you the average rate of interest you are being charged. Prepare yourself, you're going to be surprised!
Let's look at the following example:
Regardless of the payment amounts owed each month, this particular individual is being charged an average interest rate of 8.18%. Assuming minimum payments are made on any non-mortgage debt, monthly payments (excluding taxes and insurance) would be approximately $2,899. Consolidating all the debt into a new 30-Year Fixed Rate mortgage of $327,500 with an interest rate of 6.75%, would yield a mortgage payment of $2,124. This would result in a monthly cash flow savings of $775.
If the borrower were to apply this $775 monthly savings towards the reduction of his or her total debt, this person would be able to pay off the amount owed on the consumer portion in less than 29 months, or over 14 months ahead of schedule. Better yet, this individual would save nearly $11,000 in the process! Even with closing costs, this person would stand to save a lot of money.
Here's even more good news. Depending on how long you anticipate living in your home, you may find even greater savings by looking at an adjustable rate mortgage that offers a fixed interest rate for the first three, five, or seven years the mortgage is in effect.
One last point worth considering is that interest on consumer debt is not tax deductible. On the other hand, you can deduct a portion of the interest on your mortgage. Using the aforementioned example, someone in the 31% combined tax bracket is really paying an effective rate closer to 9% in total interest prior to consolidating.
If you would like to investigate debt consolidation options further, the best thing to do is place a call to your mortgage professional, who can offer advice regarding the proper path to take depending upon your situation. In just a matter of hours, you may obtain some much-needed financial relief. But call today, as interest rates are on the rise!
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