In 2006, I drowned in consumer debt. It was my fault. I carried too much consumer debt when I purchased my first home. With the no money in the bank and earning poverty-level wages, I turned to the last resort of money available, home equity.
What is Refinancing?
Home loan refinancing is the application of a loan to capitalize on the rise in home value. Two home refinance options exist, refinance the existing mortgage or add to it with a 2nd mortgage. In either option, generally a refinance is accomplished to pull out money called “equity” from the home. Equity is the difference (increase or decrease) in value from an existing home loan. Positive equity if the market value is higher, negative equity if the market value is lower than the existing home loan. A home refinance is also possible to lower the interest rate.
To quickly check the market value of a home, review recently “sold” homes on sites such as Realtor.com with similar bedrooms, bathrooms, square footage and within a mile radius. A final determination of the home’s market value will be determined by an appraisal.
Understanding Positive and Negativity Equity
Equity is a balloon, it rises in prosperous economic times, deflating when the economy falls. Positive and negative equity are predicated on the cyclical real estate market. As a rule of thumb, home values rise an estimated seven years, reach a peak and decrease over the next seven years. During the uptrend, many capitalize on a home’s appreciation, refinance money out, only to experience a drop in market value years later and find themselves in a situation where their home loan exceeds the home’s market value.
Food for thought, equity (positive or negative) on paper is not money in the bank. Yes, it is part of an individual’s net worth, but to truly realize equity, the money must be refinanced and a check issued.
My Refinancing Story
Drowning in consumer debt, home refinance was my only option. To start the process, I provided the current mortgage payment of $975 and recent check stubs to the loan officer. The home was originally purchased with a Veteran Affair (VA) loan so the interest rate on the 1st loan was fair, 6.5% for a $155,000 home loan. I chose to refinance by adding a 2nd home loan, thus creating two mortgage payments, one for the 1st loan and another for the 2nd loan.
The loan officer took my financial information and locked in the 8.25% rate (standard for a 2nd home loan at that time). I do not recall paying closing costs or origination fees because a friend helped me out. The only unfavorable piece of the 2nd loan was the term, a 15-year fixed loan, resulting in a higher monthly payment.
With my home’s market value at $225,000 and an existing 1st mortgage loan of $155,000, I decided to refinance $55,000 out of the home. I left the remaining equity because I did not need it. The $55,000 check arrived in my checking account and within two weeks, all previous debts were paid. It was a relief paying off thousands of dollars in consumer debt I carried for close to five years. Conversely, it was heart wrenching writing checks totaling $55,000 to creditors.
As a result of refinancing, my combined monthly mortgage payment totaled $1,300, $975 for the 1st and $325 for the 2nd. Not too shabby for 1,500 square foot home with three bedrooms and two bathrooms. Grant it, it was in a different state than I am presently living in but it was a home nonetheless with a manageable mortgage payment.
Refinancing was the right decision for me than. It paid off existing consumer debt, lowered my debt-to-income ratios and provided flexibility to purchase another home, in the state I am presently living in, California.