Please Critique My Idea

[Bob B.]

I've posted about my debt situation several times in the past. My wife and I are considering a monumental change. Before we go through with it, I'd like some comments from this forum. First, my current situation:

Balance Int Monthly Payment
Mort. 1 $104,165 6.25% $1125 (PITI)
Mort. 2 (A) $30,000 0.00% $0
Mort. 2 (B) $40,000 0.00% $0
CC1 $7,931 8.90% $159
CC2 $2,706 4.25% $140
CC3 $2,088 5.23% $195
CC4 $1,709 20.9% $60
Van Loan $6,550 4.20% $210

We owe two different family members a combined $70K on the house we currently live in. Our old house is rented out, and for sale, We are currently $25-30K underwater on the mortgage. Our original agreement with family members is to pay them when our old house sells.

My proposal is to take out a 30 year morgage on the house we're currently living in. The house is worth about $72K. At 80% L/V ratio, we'd borrow $57,600. I would use that money to:

1. Pay off all consumer debts (credit cards and van loan), freeing up about $760 in monthly cash flow.
2. Pay Mort. 1 down by $28K, so it is not under water at current market value.
3. Pay the rest to family members (about 12% of what we owe them)

The $760 in new monthly cash flow would be split between the new mortgage, and family members. (assuming new morgage at about $300 per month).

We have become much more financially disciplined over the past 18 or so months. I truthfully don't see us falling back into the credit card debt problem we've had in the past.

Even though our family members have not asked to be repaid yet, we feel an obligation to begin paying them back.

In the future when our house sells, we're going to have to come up with the $25-30K somehow.

Sometime after the original house sells, we would plan to refinance our new mortgage to a 10 or 15 year payoff.

[Bob B.]

After I posted, I thought a better option might be to pay off just enough consumer debt to free up the $300 per month cash flow needed for the new mortgage. Maybe the 20.99% card, the 8.9% card, and maybe the 5.32% card. And the rest of the $57,600 go to family members.

[disneysteve]

Originally Posted by Bob B.

1. Pay off all consumer debts (credit cards and van loan), freeing up about $760 in monthly cash flow.
2. Pay Mort. 1 down by $28K, so it is not under water at current market value.
3. Pay the rest to family members (about 12% of what we owe them)

The $760 in new monthly cash flow would be split between the new mortgage, and family members. (assuming new morgage at about $300 per month).

Just to be semantically correct, you aren't actually paying off the consumer debt. You are just doing a balance transfer to the new mortgage.

I'm assuming there is no official record of the family loans. If there is, that would make getting a loan impossible.

Is the rent on home 1 covering your costs? If not, rather than paying down the loan, I'd probably hold that money in reserve in case you need it. Then when the house sells, you can use it to cover the balance on the loan.

Do you have a 6-month emergency fund?

Is there anything that was purchased with that 14K of CC debt that could be sold to recoup some of that money?

[riverwed070707]

I don't know what your income is, but speaking from experience, unless you qualify for both mortgages *without* counting the rent coming in from the second property, you won't be able to get another mortgage.

Additionally, I think it's pretty strongly discouraged to roll unsecured debt into a mortgage. Sure it would help you because you aren't currently paying down your mortgage but if you do find yourself in financial distress again, you're going to owe more than the house is worth between the mortgage and family. I understand your desire to repay them, but I don't think its a smart move.

[disneysteve]

Originally Posted by riverwed070707

I think it's pretty strongly discouraged to roll unsecured debt into a mortgage. Sure it would help you because you aren't currently paying down your mortgage but if you do find yourself in financial distress again, you're going to owe more than the house is worth between the mortgage and family.

This is true. Most advice says not to convert unsecured debt to secured debt. The main reason for that is that typically people haven't changed the bad behavior that got them in trouble in the first place. The majority of home owners who used equity to pay down credit cards proceeded to run the cards up again and found themselves in even worse shape than they started.

In this case, if OP has truly reformed the money management, I'd be okay with it. Heck, my wife and I have used home equity to pay off debt - student loans and a car loan - years ago.

The problem here is what happens if the tenants move out (or stop paying rent)? Can you afford the existing loan AND the new loan? You could stop sending payments to the family at that point but will that be enough?

[Bob B.]

Originally Posted by disneysteve

Just to be semantically correct, you aren't actually paying off the consumer debt. You are just doing a balance transfer to the new mortgage.

I'm assuming there is no official record of the family loans. If there is, that would make getting a loan impossible.

Is the rent on home 1 covering your costs? If not, rather than paying down the loan, I'd probably hold that money in reserve in case you need it. Then when the house sells, you can use it to cover the balance on the loan.

Do you have a 6-month emergency fund?

Is there anything that was purchased with that 14K of CC debt that could be sold to recoup some of that money?

Correct, no official record of the family loans.

Rent on home 1 = $900/mo. so, covers 80% of costs.

EF = $1,650 so, no not 6 months.

Basically, no. We haven't added to that 14K cc debt since August 2008. And, when we were piling on CC debt, it was on eating out, clothes, gasoline, a computer that is now 4 years old, and my Master's degree. No new furniture, stereo, plasma TV or anything like that.

[Bob B.]

Originally Posted by riverwed070707

I don't know what your income is, but speaking from experience, unless you qualify for both mortgages *without* counting the rent coming in from the second property, you won't be able to get another mortgage.

Additionally, I think it's pretty strongly discouraged to roll unsecured debt into a mortgage. Sure it would help you because you aren't currently paying down your mortgage but if you do find yourself in financial distress again, you're going to owe more than the house is worth between the mortgage and family. I understand your desire to repay them, but I don't think its a smart move.

Household income = 65K

[Bob B.]

Originally Posted by disneysteve

The problem here is what happens if the tenants move out (or stop paying rent)? Can you afford the existing loan AND the new loan? You could stop sending payments to the family at that point but will that be enough?

The hope is that with the new borrowing we would be put into a position to be able to list the house at current market value, and sell more rapidly.

[disneysteve]

Originally Posted by Bob B.

Our old house is rented out, and for sale

The hope is that with the new borrowing we would be put into a position to be able to list the house at current market value, and sell more rapidly.

I'm confused. You said the house was currently for sale. Is it not listed at market value? If that's the case, why not? What's the point of having it on the market at an unrealistic price? It won't ever sell that way.

You are currently losing at least $225/month on the property. The longer you keep it, the more in the hole you are.

[Bob B.]

Originally Posted by disneysteve

Is the rent on home 1 covering your costs? If not, rather than paying down the loan, I'd probably hold that money in reserve in case you need it. Then when the house sells, you can use it to cover the balance on the loan.

My thought on sending that money towards the mortgage sooner rather than later - It's at a 6.25% int rate. To reduce the princ. by 28K now would mean $330 per month going toward princ. rather than the $195 per month going toward princ. as is.

Also, if I were to park it in a CD, were talking what? 1% or less interest earned.

But, yes I see your point in having something in reserve.

Maybe 1/2 toward principal now, and 1/2 in reserve?

[disneysteve]

Originally Posted by Bob B.

EF = $1,650 so, no not 6 months.

I would pump up the EF before paying down the mortgage or repaying the family. The rental is losing money every month and if the tenants leave, you're really in trouble, or if the place needs a costly repair.

[Bob B.]

Originally Posted by disneysteve

I'm confused. You said the house was currently for sale. Is it not listed at market value? If that's the case, why not? What's the point of having it on the market at an unrealistic price? It won't ever sell that way.

You are currently losing at least $225/month on the property. The longer you keep it, the more in the hole you are.

The house has been listed at a price that would cover what we owe on it, plus cover most of the commissions, taxes, etc. (108K). That's why I want to pump some money toward the mortgage. So we can sell it and not have to bring money to the table. We have no money to bring to the table.

[disneysteve]

Originally Posted by Bob B.

My thought on sending that money towards the mortgage sooner rather than later - It's at a 6.25% int rate. To reduce the princ. by 28K now would mean $330 per month going toward princ. rather than the $195 per month going toward princ. as is.

Originally Posted by Bob B.

The house has been listed at a price that would cover what we owe on it, plus cover most of the commissions, taxes, etc. (108K). That's why I want to pump some money toward the mortgage. So we can sell it and not have to bring money to the table. We have no money to bring to the table.

You're correct that prepaying the mortgage would save you interest but given your situation, I think holding the cash is a better strategy. Then cut the asking price to market value and when it sells, use the cash to cover the difference between what you owe and what it's worth.

Personally, I wouldn't give a bunch of money to the family until the house was settled just in case you need a couple extra thousand dollars at closing.

[riverwed070707]

I agree with Steve. If you're going to take out the mortgage, elimnate the step of paying down the 1st mortgage and just reduce the price to something that will make it sell. Then use what you've borrowed to have the money to bring to the table at closing. It doesn't make sense to pay it down before you sell.

[Bob B.]

Thanks for all your replies so far DS.

What about instead of a mortgage, we were to get a line of credit for up to 57.6K?

Borrow maybe 10K now to transfer balances from 2 high int. CCs. Freed up cash flow goes to credit line and family.

Once house 1 sells, use credit line to pay off balance due on mort 1, and pay rest to family?

[disneysteve]

Originally Posted by Bob B.

What about instead of a mortgage, we were to get a line of credit for up to 57.6K?

Borrow maybe 10K now to transfer balances from 2 high int. CCs. Freed up cash flow goes to credit line and family.

Once house 1 sells, use credit line to pay off balance due on mort 1, and pay rest to family?

There are a couple of problems with a line of credit.

1. The rate is typically higher than with a fixed rate mortgage.
2. The payments may be higher. I'm not sure how they structure the term but I don't believe it is for 30 years.
3. The rate is variable so it could climb over time.
4. If anything were to change in your credit worthiness, they could freeze your line and not allow you to take out any more money.

I think the mortgage is the better route.

[Bob B.]

I've been thinking about this and analyzing from different angles ad nauseam for the past 24 hours, and I'll say that when trying to balance risk, total interest cost, and desire to pay back family members, there is no easy answer. It's impossible to satisfy three masters.

[Petunia 100]

Bob, I think it makes no sense to have the house listed above market. It is not going to sell above market, so it may as well not be listed at all. On the other hand, a home that is priced right will sell.

You say your agreement with the family members is to pay them in full when the first house sells. So has the plan all along been to mortgage the second house at that time? If so, yes, go ahead and get the mortgage now, if you qualify. If you don't qualify, you might offer to let the lender pay some of your credit cards off in escrow from loan proceeds and see if that tilts you in the direction of qualifying.

57.6k will not be enough to pay the family members in full, and you will net less. Certainly closing costs will be coming out of that, perhaps some credit card debt too. Will either family member be OK with letting you make payments on the balance?

Another option you might explore is paying the credit cards in full (with loan proceeds) and begin repayment to family members with interest. If it were me, I would much rather pay my family member a reasonable rate of interest (say 5%) than pay a credit card lender 20%. If this is money the family member does not need immediately, a 5% return may be very appealing to them.

If paying the family members in full at the time the house sells is mandatory, then where will the short fall come from? Have you considered doing a short sale? Given your circumstances, your lender may agree.

[Bob B.]

Originally Posted by Bob B.

I've posted about my debt situation several times in the past. My wife and I are considering a monumental change. Before we go through with it, I'd like some comments from this forum. First, my current situation:

Balance Int Monthly Payment
Mort. 1 $104,165 6.25% $1125 (PITI)
Mort. 2 (A) $30,000 0.00% $0
Mort. 2 (B) $40,000 0.00% $0
CC1 $7,931 8.90% $159
CC2 $2,706 4.25% $140
CC3 $2,088 5.23% $195
CC4 $1,709 20.9% $60
Van Loan $6,550 4.20% $210

We owe two different family members a combined $70K on the house we currently live in. Our old house is rented out, and for sale, We are currently $25-30K underwater on the mortgage. Our original agreement with family members is to pay them when our old house sells.

My proposal is to take out a 30 year morgage on the house we're currently living in. The house is worth about $72K. At 80% L/V ratio, we'd borrow $57,600. I would use that money to:

1. Pay off all consumer debts (credit cards and van loan), freeing up about $760 in monthly cash flow.
2. Pay Mort. 1 down by $28K, so it is not under water at current market value.
3. Pay the rest to family members (about 12% of what we owe them)

The $760 in new monthly cash flow would be split between the new mortgage, and family members. (assuming new morgage at about $300 per month).

We have become much more financially disciplined over the past 18 or so months. I truthfully don't see us falling back into the credit card debt problem we've had in the past.

Even though our family members have not asked to be repaid yet, we feel an obligation to begin paying them back.

In the future when our house sells, we're going to have to come up with the $25-30K somehow.

Sometime after the original house sells, we would plan to refinance our new mortgage to a 10 or 15 year payoff.

I've augmented my plan. I've done a tax refund estimate that shows that we'll be getting a 5k refund.* What I would like to do is wait until March when we get our tax refund. Pay off $2,706** balance/$140 per month card, the $2,088 balance/$195 per month card and the $1,709 balance/$60 per month card.*** (I've projected that those balances will be low enough in March to be covered by the 5K refund) That will free up enough cash flow to make the payments on the new mortgage, without having to transfer balances to the new mortgage.

Use the proceeds from new loan to pay down mortgage 1 to what is needed WHEN THE HOUSE SELLS. Pay 7K to family members right away, and make $700 payments per month until house 1 sells, then reasses.

* Some may wonder why I'm getting such a big tax refund. I changed my withholdings on my W-4 last February. My tax refund would have been $900 greater ($75 per month). We have four children, or a $4,000 tax credit.

** When I originally posted, I mistakenly listed that debt with a 4.25% APR, it's actually 5.25%.

***I realize this leaves my highest balance/high interest rate card untouched. It's a matter of freeing up cash flow. To pay 5K against that card would not free up enough cash per month to make this plan work.

[riverwed070707]

I think it's a reasonable plan, but I still think you'd be better off *saving* the difference between the value of the house and the sales price than you would paying down the existing mortgage. Then you have the cash on hand to bring to the table but its not tied up in the house should, for example, it not sell or the value turns out to be even lower than you expected. You're not going to be saving in interest over such a short amount of time, and the bottom line is you can guess what the market value is but the true market value is whatever someone is willing to offer you and you won't know that price until it sells.