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Using your Home’s Equity | Managing Cash Flow & Paying Down your Mortgage

The COVID-19 pandemic has raised a lot of familiar questions about the economic outlook, interest rates, and home values for most of my clients.  Clients want to know how they can save on their monthly cash flow (not just mortgage payment), if interest rates are low enough for them, or how they can shorten the term of their mortgage loan.  Check out my past post about 4 ways to manage your home’s equity.  While all these ideas are good for Homeowners, deciding what makes sense can be overwhelming and during this time, some Homeowner’s face uncertainties with their income.  This article discusses monthly cash flow, using equity to consolidate consumer debt or point number one from my previous article.

Improving your monthly expenses will do more for you long term than the one-time economic impact payments most of us received through the CARES Act.  My recommendation for everyone is to either:

  1.  Invest in yourself by saving this money OR
  2.  Paydown or pay off debt with this money 

But paying off maybe one credit card might add an extra $35 – $55 a month to your cash flow.  Not enough to make an impact encouraging you to save monthly or enough to give you a real sense of security. 

Your home’s equity may be the solution for monthly savings.  Consider this, you owe $215,000 on your home that you purchased in 2015 for $250,000 and the value has appreciated on average 4% per year since that time.  Your Home’s value might be $305,000.  You can do a cash out refinance up to 80% Loan-to-value (LTV).  Here is the math and the appreciation chart:

Home Purchased May 2015 for $250,000 with 5% down

May 2020 Loan Balance roughly $215,000

Estimated max Home Value May 2020 $305,000

Max LTV at 80% of $305,000 (max loan amount) $244,000

Estimated cash out from refinance: $25,000

Most homeowners have credit card debt, car payments, IRS debt, student loan payments or installment loans (personal unsecured debt).  Assume this scenario has $25,000 in outstanding debt.  With high interest rates on credit cards, $29k in balances can add up to range $500 – $800 per month in payments.  Use the equity from your home and save on your total overall monthly payments:

Existing PITI payment based on principle balance owed of $217,272 with home purchased May 2015, for $250,000 with 5% down on a 30 year conventional loan at 4.375% fixed, amortized P&I payments to principle owed May 2020.  Proposed PITI payment based on loan amount $244,000 80% LTV new 30 year fixed conventional loan at 4.375%.  Rates do NOT reflect a FICO score when determining rate eligibility.  Sample provided for illustration purposes ONLY as a side-by-side comparison.  Actual loan terms, qualification terms and conditions may not be available at time of application and are subject to change.  5/19/2020.

The scenario above demonstrates the effect of using your home’s equity to consolidate debt and preserve monthly cash flow.  The savings overall is $758 per month in this sample.  This scenario shows a net positive effect of adding over $700 per month to your cash flow or in another sense, “paying” you over $700 per month since you have now eliminated those payments.  Not to mention “skipping” the mortgage payment at least one month.  A homeowner could take advantage of a significant boost to their saving account. 

Homeowners who are savvy in their financing can turn that savings around by applying it as principle reduction or setting the cash aside for a rainy day or reserve fund.  Below is an illustration of how that savings applied as principle reduction against your mortgage would not only save interest, but shorten the loan term overall:

The amortization gained is a critical resource to consider in this chart.  It is telling you that you gain nearly $128k (this scenario) by making consistent principle reduction payments on your home.  That gain represents the interest you are not paying on your mortgage giving you a “gain” in your equity. 

After that 14 years of paying additional principle, if you decide to sell your home, you net $388k in the sale of your home vs an estimated $260k if you make regular payments on the $244,000 (consolidating $25k of debt).  This is using the Forecasted appreciation model above (conservative estimate) vs the Historical. 

Most borrowers do not like the idea of consolidating debt into their mortgage because they feel they are dragging their debt along.  But, if you consider the additional savings for principle reduction towards your mortgage, or even just a portion of that savings (not to mention the appreciated value factor on your home), you gain more than enough in the long run to justify debt consolidation into your mortgage.  The additional payment is an adjustment to a way of thinking they are positive appreciating payments vs negative depreciating payments.  Remember, you were in the habit of paying it before the consolidation, now you are just allocating it in your favor.

Outside of using this savings for your mortgage, you have other options like putting the cash away for retirement in an IRA or general savings, increasing your 401k contribution or starting a college fund for your kids.  Either way, it is nice to have options to better your financial future.  I recommend to all my clients to maintain a minimum 3-month reserve on all expenses, then start using the savings to build wealth.  You should work with Financial Advisors and Mortgage Professionals who help you manage your money for your goals and who will stick with you in your planning.  Your home is too big an investment to risk not working with the right people.

The information contained in this post is meant for illustration purposes ONLY and does not reflect a FICO score or APR analysis.  Content is for demonstrating a general effect with using home equity and a cash our refinance product/program.  Actual terms and conditions may vary and may not be available to all borrowers or at time of application.  It is recommended borrowers seek the advice or their loan officer or reach out to the author of this post directly.