Consolidating Debt

By: Jennifer Lane CFP

Today we tackle debt consolidation, with a question from Stephen:

Hi Jennifer, I’m married with 2 young children living in Reading. Five years ago we took a 5/1 ARM at 3.875% thinking we were going to move into something bigger within 5 years. We didn’t and now we plan to stay here indefinitely.

In addition to the mortgages listed below we have one credit card with a balance of $12,000 at a 0% rate until Oct 2009. The payment is about $125 a month.

The ARM rate (L190) re-adjusted to 3.25% in April 2009, the L141 Equity Plus Loan is a fixed rate at 7.75%, the L142 Equity Line is a variable rate currently at 4%.

		Balance	Monthly
L141	Home Equity Plus Loan	$35,364.06	$303.82
L142	Home Equity Plus Line	$4,573.44	$50.00
L190	Mortgage Loan	$214,134.86	$1,349.54
	Total	$254,072.36

Should we consolidate all of this debt including the $12,000 credit card debt into a 30-year fixed mortgage now even though we have such a low ARM rate which can only adjust 1 point a year if it does go up at all…..or do we keep everything as is? Any suggestions and/or advice would be greatly appreciated.
Thanks, Stephen

Hi Stephen – Refinancing the mortgage looks like a good idea, but rolling the credit card balance into the total isn’t ideal. Why spread the interest for a short term expense over 30 years? In the end, you’ll pay twice again the balance in interest! It’s better to pay down the card by reducing another expense in your budget or by refinancing the mortgages and investing the savings toward the card balance. Here are a couple of options to consider.

Option 1 – We’ll call this one “ideal” because it saves you the most interest over time.
Refinance the 3 mortgages into a new fixed 25 year mortgage. Twenty five year notes are usually about the same interest rate as their 30 year cousins. Right now, Bankrate.com shows the 30 year at 5.41 percent. A 25 year mortgage would keep you on pace to pay off the home on time and still reduce your payment from $1,704 to $1,546. A tidy savings of $158 a month.

If the card resets to 20 percent let’s say, and you can add another $200 per month to the $158 you’re saving on the mortgage and the regular $125 payment, you’ll have the card paid off in under 3 years. If you can’t anti-up the extra $200 per month, the payoff on the card could take just over 6 years.

(It’s not great for your credit score to keep opening new credit card accounts, but if you haven’t opened any other new cards recently, it would be worth shopping for another low rate card come October. Alternatively, call the credit card company and ask them to give you another low rate term when this one is over. Keep paying on your accelerated schedule to get the balance paid down asap.)

Option 2 - If you’re not exactly rolling in extra money (who is these days?) Option 2 might be more doable. Refinance the mortgages to a new fixed 30 year mortgage. This will cost you more interest by extending the term, but will make cash flow easier so you can focus on the credit card. At 5.41 percent the new mortgage payment would be $1,428 per month; $276 less than you’re paying now. If you add that savings to the $125 you’re paying on the credit card, you’ll have it finished off in just over 3 years (assuming 20 percent on the card like we did in Option 1 example.) You’ll pay extra on the mortgage, but at least you’ll be set at a nice low fixed rate and you’ll be on your way to paying off the credit card.

Once you have the card paid off, don’t let the payments you were paying slip back into your budget unnoticed. Set-up an automatic savings plan to build your emergency fund, add to your retirement or 529 college savings plan or increase the amount you pay towards your mortgage principal.

Good luck and let me know how it works out for you!
Best
Jennifer

Jennifer is the founder of Compass Planning, and a weekly commentator on NECN’s Business Day at 6:30 p.m. Look for her every Tuesday, or check out her blog, Jennifer’s Compass.