(ii) If I take out a $20,000 home equity loan to pay off
my credit card debt, would my interest deduction be
different?

(iii) If, in addition to (ii) above, I take out a $96,000
cash-out mortgage refinancing loan to refinance my existing
mortgage, and use the excess cash of $36,000 (ie $96,000
less $60,000) to improve my house. How would this affect
my interest deduction?

(iv) Assume that I don’t act on (ii) and (iii). Instead,
I take out a 110% home equity loan to pay off my credit
card debt of $20,000, and lend the balance of $79,500 to my
parents to buy a house. What would my mortgage interest
deduction be like?
.
.
Whether or not your home mortgage interest is fully
deductible depends on:

(a) the date you took out the mortgage. October 13, 1987
is the important date.
.
(b) the amount of the mortgage
.
(c) how you use the proceeds of the mortgage
.
.
Let’s consider your four scenarios.
.

Scenario (i)
————
Mortgage interest is fully tax deductible if a home
mortgage is home acquisition debt as defined by the IRS.
Home acquisition debt is a home mortgage that:
.

(I) you took out after October 13, 1987, and
.
(II) you used it to buy, build or substantially improve
your qualified home (your main or second home), and
.
(III) is secured by that home.
.

Your $60,000 mortgage satisfies conditions (I), (II) and
(III), and therefore the mortgage interest on the $60,000
loan is fully deductible.
.

Your credit card debt $20,000 is not home acquisition debt
because it does not satisfy condition (II) — you have not
stated whether the $20,000 was used to build or to
substantially improve your home — and condition (III).
Therefore your credit card interest is not tax deductible.
.

—- Sidebar —-

There is a limit on home acquisition debt. The total
amount you can treat as home acquisition debt at any time
on your main home and second home cannot be more than $1
million (or $500,000 if you and your spouse filing
separately). If your home acquisition debt exceeds the
limit, the maximum deductible interest is that charged on
$1 million (or $500,000 if you and your spouse filing
separately).

—- End of sidebar —-
.
.
Scenario (ii)
————-
The IRS defines another type of loan as home equity debt.
Home equity debt is a home mortgage:
.

(A) you took out after October 13, 1987, and
(B) does not qualify as home acquisition debt, and
(C) is secured by your qualified home (your main or second
home)
.

Your $20,000 home equity loan used to pay off your credit
card debt satisfies conditions (A), (B), and (C) above, and
therefore is home equity debt under the IRS definition.
Therefore the interest on your $20,000 home equity loan is
fully tax deductible. Note that for what purposes home
equity debt is used is not relevant.
.

—- Sidebar —-

There is also a limit on home equity debt. The conditions
are:

1. The total home equity debt on your main and second
home cannot exceed $100,000 (or $50,000 if you and your
spouse filing separately), and
.
2. your home equity debt + your home acquisition debt +
your [tag]grandfathered debt[/tag] must not yield a total sum that
exceeds the fair market value of your home (grandfathered
debt is simply mortgages you took out on or before October
13, 1987). See scenario (iv) discussion below for further
clarification.

—- End of sidebar —-
.
.
Scenario (iii)
————–
Based on the conditions discussed in Scenario (i), the
entire $96,000 is home acquisition debt. Therefore the
interest on the $96,000 cash-out mortgage is fully
deductible.
.

Home acquisition debt + home equity debt = $96,000 +
$20,000 = $116,000, ie less than your home’s fair market
value of $145,000. Therefore the $20,000 home equity debt
is within the allowable limit, and so the interest on the
$20,000 is fully deductible.
.
.
Scenario (iv)
————-
Let’s set out the numbers:
.

.. Your home’s fair market value = $145,000
.

.. 110% x $145,000 = $159,500.
.

.. Your existing mortgage balance = $60,000
.

Therefore your home equity loan = $159,500 less $60,000 =
$99,500
.

The $79,500 you lend your parents is not home acquisition debt for tax purposes as the house belongs to your parents, and the house is thus not your qualified home. Therefore the entire $99,500 is your home equity debt for tax purposes.
.

Let’s recap the conditions for home equity debt:

(aa) it is taken out after October 13, 1987, and
.
(bb) it is secured by your home, and
.
(cc) it does not exceed $100,000 (or $50,000 if you and
your spouse filing separately), and
.
(dd) your home equity debt + your home acquisition debt +
your grandfathered debt must not yield a total sum greater
than your home’s fair market value.
.

Your home equity loan of $99,500 satisfies conditions
(aa), (bb), and (cc), assuming you and your spouse don’t file
separately. But it does not satisfy condition (dd) because:
.
home equity debt + home acquisition debt +
grandfathered debt = $99,500 + $60,000 + $0 = $159,500,
exceeding your home’s fair market value of $145,000.
.

Therefore your maximum eligible home equity debt under condition (dd) = $145,000 less 60,000 = $85,000.
.
Now the figures under condition (dd) look like this:
.
home equity debt + home acquisition debt +
grandfathered debt = $85,000 + $60,000 + $0 = $145,000
.
In other words, you are allowed to claim tax deduction for loan interest paid on only $85,000 of your $99,500 home equity loan.
.

Next, you have to test again to see if condition (cc) is satisfied. Now compare the result ($85,000) with condition (cc), ie $85,000 vs $100,000. Since $85,000 does not exceed the threshold of $100,000, the eligible home equity debt for tax purposes is the lower of the two, ie $85,000.
.

Summary for scenario (iv)
—————————————
(1) The interest on your existing mortgage balance of
$60,000 is tax deductible.
.
(2) Of the $99,500 home equity loan, only $85,000 qualifies as home equity debt under the IRS definition, and the interest attributable to $85,000 is tax deductible.
.
.

Generally speaking, if your existing mortgage interest rate is lower than the current market rates, you’ll be better off with a second mortgage such as a home equity loan than a cash-out refinance.

However, to be sure, you must work out some numbers and compare the cash flows of the cash-out refinance option and the home equity loan option. Such analyses are simple to carry out. Let me illustrate with some examples.

(1) The current information of your home and loan

(2) I’ve received some free quotes from a lender (let’s call this lender ‘lender x‘).

Here’s the best quote for a 15-year $55,000 home equity loan from lender x:

Assuming you’ll have the lender fees and other costs financed, you’ll borrow $55,000 + $749 + $487 = $56,236 at 8.950% fixed for 15 years.

Your monthly payment = $568.71 (you can easily get this figure from a mortgage calculator).

Therefore total payment for the home equity loan for 180 months (ie 15 years) = $568.71 x 180 = $102,368

Therefore if you take out a home equity loan, your monthly loan payment = existing mortgage monthly payment ($681.19) + new home equity loan monthly payment ($568.71).
Your total loan payment for the 15-year period = total mortgae payment ($88,554) + total home equity loan payment ($102,368) = $190,922.

(3) Here’s the best quote from lender x for a 15-year fixed-rate cash-out refinance mortgage:

Assuming you’ll have the lender fees and other closing costs financed by the lender, your refinance amount will be $126,844 so that after paying off the existing mortgage of $65,000, the lender fees of $5,055 and the other closing costs of $1,789, you’ll be left with $55,000 cash for your home improvement, ie $126,844 - $65,000 - $5,055 - $1,789 = $55,000.

Using a mortgage calculator, you’ll find out that your monthly payment = $1,003.07.

The total payment over the 15-year period for your refinance mortgage = $1,003.07 x 180 = $180,553.

Compare the two total payments:

It’s clear that taking a new cash-out refinance mortgage will ‘cost’ you less cash.

(4) Taking out a new cash-out refinance mortgage is not always cheaper. If you refinance at a higher rate, say 6.25%, you may be worse off compared with taking out the new home equity loan at 8.95% stated in paragraph (2) above, depending on the lender fees, points and other closing costs, and your income tax rate.

What you have to bear in mind is that by merely comparing interest rates you cannot be sure of making the right decision. You must work out and compare the cash flows of your various options.

As of November 9, 2007 the national average APR (annual percentage rate) for borrowers with FICO score 620-639 is 13.207% for 15-year fixed rate home equity loan, and 14.294% for HELOC. Since your credit score is below 620, you’d probably have to pay at least these rates.

If you take out a 15-year home equity loan of $20,000 at the fixed rate of 13.207%, your monthly payment will be about $256, or close to 21% of your montly income. You will not have to pay PMI (private mortgage insurance) since your LTV (loan-to-value) ratio is exactly 80%, ie 80% x $25,000 (market value) = $20,000. Your home equity loan interest is tax deductible.

It’s generally not advisable to use HELOC as a long term loan because HELOC is on adjustable rates that fluctuate from time to time according to market conditions, and so is more risky, and makes your monthly payment planning uncertain.

Instead of using your existing home to take out a home equity loan, you may consider taking out a mortgage on the second home you want to buy. For credit scores 500-579, the national average APR for a 15-year fixed-rate mortgage is 10.994% as of November 9, 2007. This is cheaper than taking out a home equity loan on your existing home. For a 15-year fixed-rate mortage of $20,000 at 10.994%, your monthly payment will be about $227, or about 19% of your monthly income. But your maximum loan amount will be $16,000 (= 80% x $20,000) only, if you want to avoid PMI. The lender’s fees and other closing costs will further reduce the net amount of loan you’ll receive. Your mortgage interest will be tax deductible.

You’ll have to shop around to find the financing option that suits you best.

Credit score is not the only criterion

Although credit scores are important, they are not the only deciding factor that lenders use when approving a mortgage. The FICO is one of the factors, not the only one.

Your low credit score can be balanced by other “offsetting factors”, eg an overall low debt-to-income ratio, large cash reserves, or large down payment. Your low credit score is not an insurmountable obstacle. Therefore it’s important that you don’t assume your low credit score will prevent you from getting a mortgage. Don’t prejudge your situation.

To get your answer, you need to first get some realistic data such as interest rates, points and closing costs. The following link gives you an excellent source of free quotes from established lenders, and you are not obligated to take out any loans from them:

Get Free Quotes for your analysis

(1) Your existing monthly loan payment
————————————————————

Although you are paying 1,276 a month, your monthly loan payment is actually 960. The balance of 316 (= 1,276 less 960) comprises your property tax and home insurance premium.

(2) Your loan-to-value ratio
——————————————-

Right now your loan-to-value is 80.6% (= 148,000 / 183,600 x 100%).

In 12 months’ time, your loan will be reduced by 11,519, ie 960 x 12, to 136,480 (= 148,000 less 11,519). Your then loan-to-value will be about 74% (= 136,480 / 183,600 x 100%), assuming your home’s appraised value will remain unchanged.

(3) How much cash will you be able to take out
————————————————————————-

If you don’t want to pay PMI, your refinanced mortgage cannot exceed 80% of your appraised value, ie 80% x 183,600 = 146,880.

Let’s assume that you’ll refinance your mortgage one year later when your loan is reduced to 136,480, as shown in paragraph (2) above. The maximum amount of cash you can take out will be your refinanced mortgage (ie 146,880) less your loan balance in 12 months’ time (ie 136,480):

146,880 - 136,480 = 10,400.

(4) What will your new monthly payment be
——————————————————————–

Set out below are some of free quotes I receive from a lender:

Note:

(i) Other closing costs include fees of closing attorney/agent, appraiser, title insurance, and credit reporting.

(ii) Total costs = Lender fees & points + Other closing costs + Govt taxes & fees

(iii) Homeowner’s insurance and property taxes are omitted

Assumption

The above free quotes are given based on the following assumptions:

(a) Loan amount = $146,880

(b) Property value =$183,600

(c) Propery type = single

(d) Product = 30 year fixed

(e) Property state = Georgia

(f) Loan purpose = Refinance with cashout

(g) You have no second mortgage/home equity lines

(h) Your current credit rating = excellent

Any of the 6 options in the table above will give you a monthly payment less than your current monthly payment of 960 (see paragraph 1 above).

The 5.500% option gives you the largest cash savings because the monthly payment is the lowest, ie 834. But this option requires the largest cash outlay — the total costs is 8,060. This will reduce your intended cash takeout of 10,400 (see paragraph 3 above) to only 2,340 (= 10,400 less 8,060). This option will thus defeat your purpose.

If you want to maximize your cash takeout, the 6.750% is your option. Your monthly payment savings will be minimal because your new monthly payment (953) is almost equal to your current monthly payment (960) , but your cash takeout will be maximized at 8,543 (= 10,400 - 1,260 - 597). Will this be acceptable to you, since your objective is to take between 10,000 and 15,000 cash out?

Summary

There is no general answer as to what your revised monthly payment will be after you refinance your mortgage. Your lender’s offers will determine your monthly payment, and also whether or not you’ll be able to meet your objective of taking out 10,000 - 15,000 cash.

You must never make your decision based on only qualitative considerations. You must always work out the numbers and analyze them. To get reliable results, you should use realistic data. You should get free quotes from lenders. There are many lenders who are keen to provide you with the relevant information. Try this good resource:

Get Free Low quotes for your analysis

Be sure that these lenders tell you their fees, points, other third parties’ fees, and all other attendant costs. Ask them for their APR (annual percentage rate) because this is the real cost of your loan. Look at the APRs in the table above. Each APR is higher than the corresponding interest rate because APRs take into account your interest costs, the lender’s fees and points. Thus APRs are more accurate measures of your overall loan cost.

Using the data in the table above, it’s clear that you can:

(a) take cash out from refinancing your mortgage, and

(b) keep the monthly payment the same as, or less than, your current monthly payment, and

(c) avoid paying PMI.

The only question remaining is: are you satisfied with less than 10,000 cash takeout?

.
.
You can explore a wide variety of financial institutions that make home equity loans, such as savings and loan associations, commercial banks, mutual savings banks, mortgage companies, and the bank where you have your checking or savings account.

.
Your local newspaper is one source where you can find the lender who offers the most attractively priced loan. Look for the lender’s shoppers guide to mortgage credit. You can find these shoppers guides in many localities. You can use them to identify the lenders with low rates.

.
In any case, the way to find the most attractive [tag]home equity loan rates[/tag] and terms is to shop around.

.
An effective way to shop around is to get no-obligation, free quotes of individualized loan rates and terms from established lenders. You don’t have to be applying for a loan in order to get these free quotes. These lenders are hungry for your business. Let them compete to impress you with their offers. They are just too happy to give you their best information that includes not only loan interest rates but also points, fees, closing costs, and other relevant information.

.
No credit check is needed for getting these free quotes. Only basic, non-intrusive particulars are required, such as your property’s locality and value, the loan amount you need, you contact details, and so on. Lenders need these data to assess your financial situation and quote you more personalized loan rates.

.
The most attractively priced home equity loan is not one that charges the lowest interest rate. Your interest rate is only one part of your mortgage loan. There are other costs that lenders charge you, such as points, fees, transaction costs, closing costs etc that may add thousands of dollars to the cost of your loan. Some lenders have different names for these costs.

.
If lenders notice that you’re hung up on loan interest rates, they may play to your weakness and offer you low rates to lure you while increasing the other costs mentioned above. From these multiple sources of income, they may reap a return (known as [tag]APR[/tag] or [tag]Annual Percentage Rate[/tag]) higher than the interest rate they charge you.

.
What you should be concerned with is your loan’s APR. To lenders, APR is their real profit. To you (the borrower), APR is your real cost. Your home equity loan rate is only one of the components of your loan’s APR.

.
When you ask for free quotes, make sure that you’re given not loan interest rates only, but also all the other costs and fees that the lenders will charge. Be sure that they quote their APRs too.

.
What we have discussed so far deals with your question on loan interest rates only. Interest rate evaluation is only one part of your loan evaluation.

.
Get your no-obligation, free quotes here.

.
.

Does my plan make sense?



I assume that your home equity loan will be a [tag]fixed-rate loan[/tag] over 15 years, just as your existing mortgage at 5.5% fixed over 30 years. It is not advisable to use [tag]HELOC[/tag] ([tag]home equity line of credit[/tag]) because its rate varies according to market conditions. Under adverse conditions, its rates might exceed your portfolio’s ROI (return on investment), and therefore HELOC is risky for long-term purposes. No one can predict interest rates for 15 years ahead.

.
To evaluate any financial plans, we must crunch the numbers and evaluate the results. I have set up the figures for you in this spreadsheet.

.
You can see your [tag]loan amortization schedule[/tag] for the $65,000 home equity loan in the spreadsheet. Your monthly repayment installment is $584. You are right — you can use your monthly excess cash of $600 to repay the home equity loan.

.
Before we evaluate the results, let me spell out my assumptions underlying the figures:

(a) You are in the 25% tax bracket

.
(b) Your [tag]mutual fund[/tag] pays you dividends every month

.
(c) You do not reinvest your dividends

.
(d) There are no capital gains and no capital losses

.
(e) All your dividends are qualified and taxed at 15%

.
(f) You are very disciplined and set aside the tax on your dividends (referred to in (e) above) every month

.
.
Evaluating your investment model
—————————————————

(1) Your [tag]home equity loan interest is tax deductible[/tag]

.
Since your home equity loan is less than $100,000, all of its interest is tax deductible under the IRS rules. Since I assume you are in the 25% tax bracket, you save 25% tax on each interest payment. The tax savings are calculated and listed in the spreadsheet. Your real loan interest should be net of tax savings. For example, the real month 1 loan interest = 379 - 94.75 = 284.25.

.
(2) Calculate your after-tax net profit

Remember assumption (f) stated above.

.
If we assume your mutual fund pays 12% dividends each year for 15 years without fail, you will make an after-tax net profit every month. For example, your month 1 after-tax net profit = 553 - 284.25 (see para (2) above) = 268 approximately (see spreadsheet).

.
The table in the spreadsheet shows that your mutual fund is profitable every month throughout the 15 years, yielding a cumulative after-tax net profit of $69,330 by the 180 months.

.
It is obvious that your mutual fund will be profitable because its targeted ROI (12%) is higher than the loan interest cost (7%). The profitability is further boosted by the higher tax savings (25%) on the loan interest vis-a-vis the lower tax cost (15%) on the dividends.

.
Similarly, at 10% ROI your mutual fund will be profitable.

.
(3) BUT… consider the cash flows

Now we need to see if your mutual fund will put extra CASH into your pocket.

.
To do this, simply subtract your monthly loan repayment from your monthly dividends received less 15% tax (remember assumption (f) stated above). Since the IRS does not give you a check every month for the tax savings on the loan interest, your monthly cash outflow is $584 — your monthly loan repayment. In other words, you do not have a monthly stream of “net-of-tax” cash outflows. Your tax savings are given back to you in computing your tax liability, and not in cash directly.

.
Under both the 12% and 10% ROI scenarios, there are monthly cash shortfalls, viz. $32 and $124 respectively (see spreadsheet). This means the net-of-tax dividends received are not sufficient to pay for the loan interest and principal each month. You will not see extra cash coming in every month. On the contrary, you will have to use part of your $600 monthly savings to cover the shortfalls.

.
This cash loss is caused by the 15% tax. Take the 12% ROI case for example. The gross monthly dividend is $650. After paying the monthly loan installment, you are left with excess cash of $66, ie 650 - 584 = 66. But you have to pay 15% tax that works out to be $98, ie 650 x 15% = 98. Your excess cash of $66 is not sufficient to pay the tax. You have to come up with $32 to make up the shortfall, ie 66 + 32 = 98.

.
(4) The bottom line

The bottom line is that your mutual fund will be a loss-making one. When the ROI drops by 2% from 12% to 10%, the cash loss increases by almost 4 times, ie -$22,234 vs -$5,710. The targeted return of 10% - 12% is simply not enough to generate sufficient cash to pay the loan and tax.

.
(5) Important point to note

Always evaluate cash flows. Evaluating only ROIs as we do in paragraph (3) above may lead us to wrong decisions.

.
.
Change assumption (c) — Re-invest your dividends
————————————————————————————-

Now let’s use the following assumptions:

(a) You are in the 25% tax bracket

.
(b) All your dividends are qualified and taxed at 15%

.
(c) Your mutual fund pays dividends monthly.

.
(d) You reinvest 85% of your monthly dividends, and take out 15% to keep aside for paying the tax. (In practice you would probably reinvest 100% of the monthly dividends.)

.
(e) You will use your $600 to pay your monthly loan installment of $584.

.
(f) There are no capital gains and no capital losses

.
Based on these assumptions, I have set up new tables of figures in spreadsheet 2.

.
.
Analyzing the figures
——————————-

With the reinvestment of dividends, your monthly dividends increase (see column 3 (col3) in the mutual fund tables in spreadsheet 2) because of the compounding effects.

.
At 12%, you will start making after-tax net cash profits from month 15 onwards (see (col 6) - “After-tax net cash flows” in spreadsheet 2). By the time you fully pay off the home equity loan in month 180, you will have made a total of about $128k after-tax net cash surplus (this is the last figure in (col 6) - “After-tax net cash flows“) .

.
At 10%, your mutual fund will start making after-tax net cash surplus only in month 66, and generate a total of about $61k by the 15th year.

.
Since your targeted ROI is between 10% - 12%, you would expect to start making cash surplus between month 15 and month 66.

.
.
How do we arrive at the after-tax net cash flows
—————————————————————————-

Look at the table of figures of the mutual fund @12% in spreadsheet 2. Here are the steps:

.
(i) We accumulate the “after-tax dividend re-invested” (col 3) month by month, and record the monthly cumulative figures in (col 4).

.
(ii) Then we accumulate the monthly loan repayments ($584) that you make with your $600 cash in hand, and record them in (col 5). Compare (col 4) and (col 5).

.
(iii) Subtract (col 5) from (col 4). The results are recorded in (col 6) — “After-tax net cash flows“. The negative figures in (col 6) represent losses, and the positive figures represent after-tax net cash dividends.

.
.
Conclusion
—————-

(1) For your investment plan to be profitable, you will need to reinvest your dividends to take advantage of the power of compounding.

.
(2) Bear in mind that our analyses assume that your mutual fund will pay the targeted return of 10% or 12% constantly over 15 years. This is unlikely in reality.

.
(3) Understand that your mutual fund’s value may drop if the market moves against it. There is always risk in investing.

.
(4) We have seen that there is a vast difference in the break-even periods between 12% return and 10% return, viz. 15 months vs 66 months. A small change in the rates of return brings about a considerable change in the profitability. This means the profitability is very sensitive to the rates of return.

.
Therefore if your mutual fund’s return drops below 10%, it will take an even longer period to break even. Your investment may turn into a loss.

.
(5) It is risky to use borrowed money for investment. You are bound to the [tag]loan repayment schedule[/tag] whether your investment makes profits or loses money. Take for example your mutual fund that will pay 12% return. Your net-of-tax monthly dividend is $650 x 85% = $553. If you use $65,000 of your own money to invest in the mutual fund, this $552 will be entirely cash profit in your hands. But, as we have seen, when you use $65,000 home equity loan to invest in the mutual fund, you will end up with a cash loss of $32 each month. What a world of difference!

.
Remember the 4th Quadrant (the Investor Quadrant) in the book, CashFlow Quadrant, written by [tag]Robert Kiyosaki[/tag]? He suggests that the ultimate position to get into is the Investor Quadrant where you use money to make money for you. But he suggests you use your own money, not borrowed money.

.
(6) When evaluating your investment models, always analyse and evaluate the relevant cash flows.

.
No doubt, you will do more research and get plenty of investment experts’ advice before you make your decision. Events and circumstances that cause turbulence to the stock markets are arising more frequently nowadays. Many unforeseen things can happen in 15 years ahead.

(iii) Currently my interest-only payment is just over $800 a month. If I repay $1,000 principal every month, will I be better or worse off?


(i) You will pay off the entire loan in 93 months. The final repayment installment is $960.

(ii) You will have paid $42,560 interest in total.

I have set out the numbers for you under Scenario 1 in this spreadsheet. Be sure to scroll down to the bottom of Scenario 1 to see the summarized figures.

(iii) Repaying $1,000 principal every month

(a) It will not make a difference if you repay $1,800 every month

If you pay $1,800 every month, the results will be answers (i) and (ii). There will not be any changes in the results. The monthly interest will be paid off first from your $1,800 monthly installment, and then whatever amount of money left of the $1,800 is used towards repaying the principal.

.
Scenario 1 shows the monthly interest and principal paid. Go back to Scenario 1, and you will see that in month 1 $827 interest is paid, while $973 principal is paid. In month 2 $820 and $980 interest and principal are paid respectively. Each month’s interest and principal paid add up to $1,800. This is how your monthly installment is apportioned between interest payment and principal payment.

.
In Scenario 1 you may have already noticed that in each successive month the principal paid increases while the interest paid decreases. You can see that after month 5 the principal paid each month exceeds $1,000.

.
.
(b) You will end up paying more interest if you stipulate $1,000 monthly principal repayment
.
If you agree with your lender that you will pay $1,000 principal each month, you will repay your loan according to the [tag]loan repayment schedule[/tag] shown under Scenario 2 . You will be worse off as follows:

.
(1) You will fully pay off your loan in 124 months vis-a-vis 93 months in Scenario 1. This is because you pay off the outstanding principal at a slower rate in Scenario 2, thus stretching the loan period.

.
(2) Your monthly repayment installments will no longer be constant: they decrease in each successive period. You will have to pay $1,826.67 in month 1, $1,820 in month 2, $1,813.33 in month 3, and so on (see Scenario 2 “Repay” column). This may cause you some inconvenience in administering your monthly repayments.

.
(3) You will have paid $9,106.67 more interest at the end of the loan period. Scroll down to the bottom of Scenario 2 to see the summarized figures.

.

Should I refinance my home equity loan to consolidate my credit card debt?

Obviously it is advantageous for you to consolidate your credit card debt because:
.

(a) you will save interest because you will be using the cheaper home equity loan to replace your more expensive credit card loan, and
.

(b) having your credit card debt paid off will result in a lower credit card utilization rate which in turn will improve your credit score.

.

Financing option
————————-
How are you going to raise the $30k to clear your credit card debt?
.

(1) One option is to increase your home equity line by $30k, assuming that you still have available home equity to do so. This will bring your total home equity debt up to $200k.
.

(2) The other option is to ask your first mortgage lender to lend you another $200k that you will then use to pay off both your home equity loan and credit card debt. This is advantageous because first mortgage is usually cheaper than second home loan such as your home equity loan.

.

Points to note
———————
(A) Your current situation has a tax disadvantage here. While you can deduct your home equity loan interest for tax purposes, your eligible home equity loan is limited to a maximum of $100k only. The interest you pay on the remaining $70k of your home equity loan is not eligible for tax deduction. Financing option (1) stated above will not increase your tax deduction for the loan interest.
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If you choose financing option (2) to borrow the $200k (ie $170k + $30k) from your first mortgage lender, you will increase your interest savings as mortgage interest rates are lower than home equity loan rates. Of this $200k new first mortgage, interest on $100k is still eligible for tax deduction.
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It does not matter what the loan is called, either first mortgage or home equity loan. For the purposes of tax deduction for mortgage interest, as long as the loan secured on your home is not used for buying or improving your home, the loan amount — whose interest is eligible for tax deduction — is limited to a maximum of $100k only.

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(B) You should ascertain the appraised value of your home. If your total borrowings exceed 80% of your home’s appraised value, you will have to buy private mortgage insurance (PMI) to protect your lender against your default. PMI will increase your loan costs. Your total borrowings will be $390k (ie $190k + $170k + $30k new loan), and so your home’s appraised value has to be at least $488k to avoid having to pay PMI ($390k � $488k x 100% = 80%).

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The bottom line is that you must work out the numbers (eg the interest charges, closing costs, monthly repayment amount, total loan interest over the loan period, APR, etc) under each possible option to determine the best choice before you make your decision.
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