Debt Roll-down - Part 2 of a 3 Part Series - Using a Mortgage to Accelerate Debt Payments
In last month's newsletter, we discussed the importance of eliminating "bad debts" - debts that do not help us make money. We laid out a debt elimination calendar to easily accelerate the payment of debts - even if you don't have any extra money right now to put toward debt payments. This month, we will discuss one specific strategy for eliminating debts even more quickly! Next month's issue will contain more strategies and ideas.
The best way to eliminate debts as quickly as possible is to create the biggest "margin" possible and then apply that margin toward debt payments. Creating a margin simply means finding ways to lower your payments and/or expenses so you have more money available to you each month. Many times the way to create the largest margin is by using a mortgage.
For example, let's say this is your situation*:
Home value: $220,000
1st mortgage amount: $156,000
2nd mortgage amount: $20,000
1st Car loan amount: $11,000
2nd Car loan amount: $9,000
1st Credit card balance: $6,800
2nd Credit card balance: $3,000
Department store card balance: $1,200
Total monthly payments: $2,750
Now, let's say that you determine, after consulting with a mortgage professional, that you can consolidate some of your debts into a new mortgage. After consolidating a few debts and leaving the others alone, your new total monthly payment is $2,550. You now have $200 a month available to you to accelerate the payment of your debts. That $200 a month will yield tremendous results when it comes to eliminating your debts.* In fact, using this scenario, if you used that $200 a month to pay off your debts and did not accrue any new debt, you could have everything paid off, including your mortgage, in under 10 years! You could also save $155,000 in interest payments.
Not only that, but because you have everything paid off in 10 years, you now have the other 20 that you would have been paying on your mortgage to save up a significant amount of money for retirement. In fact, assuming you continued to contribute the full $2,750 toward savings after the debts are paid off, you would have $1,200,000 saved (earning a very conservative 6%) after the full 30 years were up.
Some important considerations when deciding whether or not to consolidate debt into a mortgage as part of a debt elimination plan include:
* Should you get a fixed rate vs. variable rate mortgage? If your debt elimination plan has you getting out of debt in 7 years, for example, you may want to consider a mortgage that has a fixed interest rate for 5 years or 7 years, since you will likely not be paying on it for the full 30 years. Your rate may be lower that way. Sometimes a variable rate mortgage can save you even more money and pay off your debts faster.
* Make sure you factor the costs of the new mortgage loan into your debt elimination plan. If the costs are too, high, it may not make sense. Also, if you plan to sell your house within a short amount of time, it may be better to wait until the house sells, and use some of the equity money to pay off your debts instead of refinancing.
* If your new mortgage is over 80% of the value of the home and you will be required to pay mortgage insurance, make sure to factor that cost into your calculations. Paying mortgage insurance is not necessarily bad. If it helps you create a larger margin, it may make more sense to pay mortgage insurance than to make a credit card payment carrying a high interest rate.
Please understand that we do not recommend debt consolidation loans for the sole purpose of reducing monthly payments. In the mortgage side of our business, we see many people who have done debt consolidation loans, reduced their monthly debt payments, and then went out and ran up the credit card balance again, or bought a new truck, etc. This strategy is not at all effective in eliminating debt and is extremely detrimental to making financial progress. We only recommend consolidating debt into a mortgage if you are committed to an effective debt elimination / savings strategy that will put you in a better financial situation than you are currently in.
As was stated in last month's newsletter, the most important step in eliminating debt effectively is not incurring new debt. If you want to get ahead financially, commit now to stop buying things on credit that do not help you make money. Then create a strategy to eliminate the debt you do have. Stick to it, and your debts will be gone quicker than you think.
If you would like more information on debt elimination plans, please visit
www.contractormd.com and click on the "Debt Elimination Plan" link in the right taskbar toward the bottom of the page. And don't forget to read next month's column where we will give you several more strategies for eliminating debt quickly. These other strategies can be implemented whether you have a mortgage or not.
* The scenario listed in this example is hypothetical. The actual time required to be debt-free, the amount of interest saved, and the savings amount after 30 years depends on many factors including the balance of existing debts, the interest rate assigned to each one, the payment structure of each debt, mortgage qualifications, current mortgage interest rates, and other factors. Every situation is different and as such, this example is intended to serve as an explanation of these financial principles only, not as an exact illustration of any actual debt elimination plan.
-by Dan Wattleworth
Director of Coaching
Financial M.D. & Associates
www.contractormd.com
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