Okay let’s show how an actual couple ended up freeing $915.80/month by refinancing their home. I’ve rounded the numbers, but they are from a real life scenario. We’ll begin with a snapshot of what their financial situation was BEFORE:
Home Value: $250,000
Mortgage: $150,000 balance, 20 years left, 6% interest rate = $1,070 Monthly Payment
Credit Card Debt: $10,000 balance, 18.8% interest rate = $500 Monthly Payment
Vehicle Loan: $26,000 balance, 8% interest rate = $500 Monthly Payment
Department Store Charge Cards: $5,000 balance, 28.8% interest rate = $250 Monthly Payment
In this case, they have a total debt obligation of $191,000 and total monthly payments of $2,320.
By refinancing, they were able to take out $41,000 of equity from their house to pay out the vehicle loan, the credit cards and the department store charge cards. This increases the mortgage from $150,000 to $191,000. Plus, let’s add a $5,000 charge to break their existing mortgage for a total new mortgage balance of $196,000.
However, that entire amount is now being charged 6% interest and amortized over 20 years. The new mortgage payment is $1,404.20. …but that’s the only payment.
So: Old Total Monthly Payment ($2,320.00) – New Total Monthly Payment ($1,404.20) =
$915.80 Saved Per Month
Take this with a grain of salt. You have to factor in the trade-offs. Yes, you free up a lot of money monthly, but it has to be put to good and productive use. Also, before they would have freed up the $500 monthly vehicle loan payment in 4 years anyways, but now they blended it into a 20 year mortgage, effectively paying for that vehicle for 20 years. In many cases, these trade-offs are more than acceptable to people who are looking into refinancing as they are in dire need of a short term solution and even just a little breathing room is enough of a dangling carrot for them to proceed. In this particular case, a $915.80 monthly savings was very compelling and they are currently saving $700/month out of that into an investment account.
I know this is an old post, but why wouldn’t they just take a HELOC instead so that they have better payment flexibility?
Good question. That can be an option depending on a few factors, most of them subjective. Sometimes a HELOC (Home Equity Line Of Credit) can compound their problem. You have to understand the nature of their problem isn’t that they are bad at math – they view credit as entitlement. In other words if you give them a line of credit for $10,000, it will be close to maxed in short order. Normally the people who are ready for a refinance are those that have multiple lines of credit, credit cards and department store cards, etc. Drastic times call for drastic measures.
A refinance is more than just a financial strategy, it can be the start of a control-alt-delete for their overall financial philosophy. They have been spiraling into worse and worse of a situation and an "intervention" was required.
In any case, while a HELOC might be a good choice for those who are normally very good with their budgeting but are temporarily under the gun, a refinance may be reserved for those who are further a-stray.
In such cases, it would be wise to have a professional advisor force them to cut up and cancel their cards, and monitor them quite closely for the first few months after the refinance – otherwise they can get themselves into even MORE trouble with the new found cashflow and perception that they fixed the problem. Remember the problem is a psychological one.
Excellent question.