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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.

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4 Ways to Manage Your Home’s Equity

Many people have asked me recently how they should manage their home’s equity now that the housing market has stabilized.  It’s a great question and one that signals signs of health and growth in the housing market.  Here are 4 ways to manage the equity in your home.

  1. Payoff Debt

Your home is like a bank where the value can be turned into cash for what you do not owe on the original loan, within reason.  Many of my clients are finding their home’s value is a great vehicle to manage their monthly cash flow and payoff their consumer debt such as credit cards or personal loans.  Remember that the interest on credit cards is not amortized to be “paid off” anytime soon and the interest you pay on revolving debt and most personal loans is much higher. 

Through a cash-out refinance on your first mortgage, you can take the equity and apply that money to paying off your debt.  We recently closed a loan with this very scenario and the borrower is saving $1400 a month on their expenses by consolidating their credit card debt into a refinance.  Their mortgage payment goes up, but their monthly cash flow goes down significantly.  See below:

2. Home Improvements

Home improvements can do a lot for your home’s value in the future, not to mention it’s resale value when you decide to upgrade or right-size your home. You can access the equity in your home for home improvements either through a cash-out refinance or Home Equity Line of Credit/Loan (HELOC).  Both offer their advantages depending on your goals.  You can also use a Renovation Loan through FHA’s 203k loan program or Conventional’s Homestyle loan program.  Check out my Blog Post on the Renovation loans.

Some banks and credit unions will consider a HELOC for home renovations at a greater loan-to-value (LTV).  For example, one institution goes up to 130% LTV for home improvements with a General Contractor bid.  Others will go up to 100% LTV on a HELOC.  But you MUST read your loan terms. 

HELOC’s are generally interest only payments for the first 10 years meaning you are not reducing any of the principle money owed.  This is why a HELOC is not a good option for debt consolidation.  You should have a strategy for paying off your HELOC or Equity Loan before signing the paperwork.  This can make doing a simple cash-out refinance more attractive because the risk is less involved only making one house payment vs two! Here is a resource guide for HELOCs and shopping around for the best products.

3. Sell your home & Payoff Debt

You’re kidding right?  Why would I sell my home and buy another when I’d be paying more for the house and a higher rate on my mortgage?  6 Reasons to Buy a Home

Great question!  It’s because if you are paying a lot of consumer debt you can payoff that debt from the sale proceeds and still put a down payment on a new home.  In the end, you can save on your overall monthly expenses and truly save that additional cash you’d otherwise be paying on debt.  It’s an opportunity if you are contemplating buying a new home and don’t know how it will affect your monthly expenses considering the mortgage payment may be higher than what you are paying.

Take the image above as an example.  This borrower can sell their home at market value, take the equity and payoff $35k in consumer debt totaling $1,274 in monthly minimum payments.  They will still have funds left over for a 5% down payment on a conventional loan and save $454 a month overall with a new mortgage on a new home. 

We can take it a step further and take the $983 they are saving through debt consolidation and apply that as a principle reduction on their mortgage every month.  They will pay off their mortgage in less than 15 years and ultimately save over $80k on interest.  Pair this with an Adjustable Rate Mortgage (ARM) product and you can understand the power of prepaying your mortgage.  Mortgage qualifying is more than the interest rate but the planning for wealth in the future.

Housing Strong Going into 2019

4. Sit & Relax

The last way to manage your home’s equity?  Do nothing at all and enjoy the appreciated gains.  Just because I love German Chocolate Cake doesn’t mean I eat it every day.  Sure, it’s not as much fun and you could do other things that aren’t limited to this list.  You can get creative and start a business, invest in other real estate, make principle reduction payments, or buy your vacation home. 

Whatever you decide, just be smart in your decision and planning processes.  Get your own Homebot Report or read my latest Blog Post on Homebot.  The sit & relax approach is having the confidence knowing you have access to your home’s equity when you need it or when an opportunity arises.  If you are interested in a FREE report on how your Home Equity can be used, send me a message and we will discuss your options!  Thanks for reading.

-Chris