January 17, 2019

I have recently seen A LOT of ads from mortgage companies advertising the ability to “consolidate your debt”. Sounds great, but what’s the real story?

What they are doing is trying to get you into a cash-out loan. Cash-out loans are not a bad thing, and debt consolidation may be the way to go for some people. The problem here is they want put you into a new first-lien cash-out loan that wipes out your existing loan and gives you cash back to pay off other debt (credit cards, student loans, auto loans, etc). That would be OK, except there is a pretty good chance that the interest rate on this new loan will be HIGHER than what you currently have. There is a better alternative, which they are not going to tell you about because they won’t make nearly as much money.

The better alternative is a 2nd lien cash-out loan, which will leave your current low-interest first lien in place. This can be either a home equity term loan or a home equity line of credit (HELOC). There are pros and cons to each, which I will go into now…

The good thing about a home equity term loan is that it has a fixed interest rate. This a great thing in an era of rising Fed Funds rates. The downside to a term loan is that you get a lump sum of cash to do whatever you want with, even if you don’t need ALL that cash right away. So you will be paying interest on money you may not be using. Also, once you pay down the principal, you no longer have access to those funds.

A HELOC is basically a very low-interest credit card (but usually with no actual “card”) that is attached (metaphorically, not literally) to your home. You obtain a HELOC — usually takes about 3-4 weeks — and you use whatever portion you need to pay off other debts. You pay it down and borrow more as you need, so you are only paying interest on what you use. That is the good part of a HELOC. The bad part about a HELOC is the interest rate is variable based on the prime rate, just like a credit card. This is not a good thing in an era of rising Fed Funds rates. Most HELOCs are structured such that you can borrow and pay down as needed for the first 5 or 10 years, after which the line closes and you have to make regular payments to pay it off in a certain number of years, or you can refinance into a new HELOC. Another negative about HELOCs is they are treated like credit cards when it comes to credit scoring. So if you max out your HELOC, your credit scores will most likely take a tumble.

When people call me looking to access the equity in their home, the first question I ask is, “what is your current interest rate?” If it is lower than what you can get on a new cash-out loan, then I direct them to a local credit union for a new 2nd lien. Now, you’re probably thinking, “how does he make any money referring his clients to another lender?” The answer is, “I don’t!” But it’s the right thing to do. I think of myself first and foremost as a consultant, a go-to guy for all mortgage-related issues.

So call me before you respond to any ads about debt consolidation!

Regards,

Ashby McDonald