How good is this?

Posted: Sep 19, 2006 12:00 AM

The title to a text is designed to catch your attention and get you to read the article. I had a much better title in mind but I was afraid "Free Money" would elicit too many responses that are unfit to print so I stuck with what I have come up with: "How Good is This". I must admit that "Free Money" is a much flashier title, and after all, that is what I am going to talk about, but this way I eliminate a lot of skeptics right from the start.

Is there such a thing as free money? I believe there is. There is also "almost free money" that exists in the mortgage industry, or others may say partial free money.

Then there are those who will read this and simply say it is all B.S. The only thing I can say is to use your own definition and come up with your own conclusions. In my opinion, if you have a long-term debt(s) and a fixed payment on said debt and you can refinance to a shorter term and take some cash out of the property, it could happen under the following circumstances. If your new payment is lower than your old payment and you pay it back quicker, then what did you pay for the cash? Nothing!

Example #1:

30 year fixed @7.5% (Believe it or not many of these exist)

Original Balance of $240,000,with a payment of $1,678/mo.

Current balance after 6 years $224,000

HELOC @ 8.75% $100,000, 30-year interest only payment of $729/mo.

Balance after 1 year $100,000

Total monthly payment $2,407 on $324,000 balance.

20 year fixed @6.00% on $336,000 has a payment of $2,407/mo.

The borrower who does this gets approximately $13,000 and doesn't increase his payment, retires his debt 4 years earlier than the first, and earlier than the HELOC because the HELOC isn't being amortized. It is being paid interest only. If you paid the HELOC at a 20 year amortization, your payment would go up $93 a month which would allow the borrower to take a larger loan, $349,000, keep the payment the same, and still pay zero for the now $26,000 cash out, because he still finishes 4 years ahead of the 30 year first mortgage.

Different interest rates will yield different results.

I can come up with hundreds of scenarios that will demonstrate my point, but it isn't the area I wish to really demonstrate. The area I want to concentrate on is the one where credit cards are plentiful. The results are staggering and can really make a difference in your life.

Let us take an example where a borrower has a 30 year fixed at 6.75% for $350,000 with a payment of $2,270/mo, and credit cards of $45,000 with monthly payments of $1,195. Under the new rules for credit cards, 1% of the balance has to be paid back every month, which means the entire balance will be paid in about 10 to 12 years (It should be 8.33 years but you are paying back 1% of the new balance, not 1% of the original balance). Let us add a car payment of $360 a month on a balance of $17,000 that will be paid off in 4 years. Total debt is $412,000 and total payments are $3,825. This is the type of situation most people who write to me are in and can't easily find a way out.

If we were to replace the $412,000 debt above with a new l5 year fixed loan of $447,000, taking about $45,000 out in cash to build a reserve so the borrower will not have to return to the credit cards, at an interest rate of 5.875%, the payment will be $3,742/mo. and would be lower than the total payment above of $3,825/ mo.

People tell me that they are not interested in paying their credit cards or their car for 15 years but these borrowers do not really understand how a shorter amortizing loan works. In 12 months your balance goes from $447,000 to $429,487, and with it, the balance owed on the auto. In 38 months, a tad over 3 years, the $45,000 owed on the credit cards is gone, as the balance is now down to $384,000+.

Let's see where you are at 38 months into the new loan. You are $34,000 higher on your home mortgage than you were a little over 3 years ago, but you haven't any debt, as your credit cards and auto payments have been accounted for. You also have $45,000 in your bank. Net result: Your debt is $28,000 lower (auto and credit card debt retired, but mortgage higher), and your assets are $45,000 higher. You are $73,000 to the better side of the balance sheet -- assets.

After 48 months, the car loan would have dropped off and from that point forward your $45,000 would be costing you about $260 a month. During the 10 to 12 years you would have the credit cards, without adding anything to the balance, your payment amount would decrease until it reached zero when they were finally gone. You also would have earned interest on the $45,000 to offset some of the cost.

You have had free money for at least 4 years, but what you really have done is given yourself the opportunity of taking a shorter amortization and completely changing your financial future. In 7 1/2 years you would owe $274,000 on the 15-year loan and if you had stayed put, the 30 year would be down to only $315,000. In 10 years you would owe $197,000 on the 15 year, and $299,000 on the 30 year. When you are completely paid off on the 15-year you would have still owed $257,000 on the 30 years.

Better than all that, with your reserves you probably would have stayed out of the credit card game. Unlike so many who have paid off their credit cards and didn't have a reserve, you would not be facing the entire mess again.

The example above is just that, an example. You may mirror that or have an entirely different scenario, but it doesn't change the fact that you can get onto the road to financial freedom with some careful planning and execution of the results of the planning.

Roger Schlesinger's Mortgage Minute is heard on hundreds of radio stations and daily on the Hugh Hewitt radio show and Michael Medved shows. Roger interacts with his hosts and explores the complicated financial markets in order to enlighten his listeners and direct them along their own unique road to financial freedom. Roger is the President and founder of Manhattan West Mortgage.