- The Washington Times - Friday, September 25, 2009

Q. My wife stopped working a couple of years ago, and we have managed to accrue $40,000 in high-interest credit-card debt. We spoke with a mortgage broker who suggested we refinance our existing mortgage and take cash out to pay off the cards. Our current rate is 5.50 percent with a balance of $250,000. Our home is worth at least $500,000. I make $120,000 as a federal employee, and I have more than $100,000 in my Thrift Savings Plan.

My father-in-law says that the loan officer is just trying to sell us a loan. He says it’s not wise to waste our home equity paying off the credit cards, even though the refinance will free up about $1,000 per month in cash flow, which would help us tremendously.

What do you recommend?

A. With all due respect to your father-in-law, I think the right type of refinance is in order. While there are undoubtedly a lot of unscrupulous loan officers out there, there are some of us (believe it or not) who give advice based upon the client’s best interest.

Your numbers make sense. Borrowing an additional $40,000 on a mortgage will increase your payment by about $220 per month. The minimum payment on $40,000 in credit-card debt is usually about 3 percent of the balance, making your payment $1,200 per month.

The net cash-flow reduction is, indeed, about $1,000. While your income alone is generally considered to be sufficient to carry your current debt load, it’s not unusual for folks to experience some degree of “cash-flow shock” when they drop from two income sources to one. It is often compounded with higher expenses, such as a growing family.

Taking $40,000 out by increasing your mortgage balance isn’t “wasting” your equity. You are simply transferring $40,000 of existing debt to another form of debt. In fact, you would be transferring $40,000 of high-interest debt where the interest is not tax-deductible to low-interest debt where the interest is tax-deductible.

In fact, as I look at today’s market rates, I see I could offer you a 5.25 percent 30-year fixed-rate loan with no points or closing costs. This would not only drastically reduce the borrowing costs of your existing $40,000 consumer debt, but also would reduce the rate on your existing mortgage balance by 0.25 percent.

At the same time, it would free up $1,000 in cash flow, which is akin to having additional taxable income of perhaps $18,000 or $20,000 per year.

Your father-in-law is possibly worried that once you take out $40,000 to pay down your credit cards, you will quickly overspend and jack up the balances again, resulting in more debt.

If you refinance in order to pay off your credit-card debt, you must prepare a budget that enables you to pay off your credit-card balances to zero every month. It shouldn’t be too difficult because you are starting with a reduction in cash outflow to the tune of $1,000 per month.

Henry Savage is president of PMC Mortgage Corp. in Alexandria. Reach him by e-mail at [email protected]

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