Spreads, costs rise on debt -- unless Uncle Sam is a buyer MarketWatch - Dec 5, 2008 On Friday, the New York Fed bought $5 billion from dealers of debt sold by the big mortgage-finance agencies Fannie Mae, Freddie Mac and the Federal Home ...
Vick sacked by debt Atlanta Journal Constitution, USA - He paid Frink?s mortgage and gave her $1000 a month for clothes, court records say, and $300 for ?beauty-related expenses.? He supported Taylor and their ...
Treasury Auctions Set for This Week New York Times, United States - Aug 3, 2008 New Jersey Economic Development Authority, $344.9 million of debt securities for New Jersey Transit light rail conversion. Morgan Stanley. ...
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Can Debt Be Consolidated in a New Purchase Mortgage?
"I am buying a house and wonder if I can roll my existing debt into my home loan at the time of purchase?" Usually you can, although that doesn’t necessarily mean you should. When you roll debt into the loan, the loan amount is larger and the down payment is correspondingly smaller. If the lender accepts the smaller down payment, fine, you can roll the debt into the loan.
For example, let’s say you are buying a $200,000 house with a $180,000 loan. The down payment is $20,000 or 10% of the price. If you roll in $10,000 of debt, the loan would rise to $190,000, reducing the down payment to $10,000 or 5% of price. Most loan programs allow a 5% down payment. Suppose you need a $190,000 loan without debt consolidation.
If you consolidate, you need a $200,000 loan, which would eliminate your down payment altogether. Most loan programs don’t allow a zero down payment, but some do. Homebuyers consolidate because mortgage interest rates are usually lower than rates on other debt, and mortgage interest is tax deductible.
Basing a decision on these differences alone, however, can be a serious mistake. Generally, the interest rate, mortgage insurance premium or both are higher on a mortgage with a smaller down payment. If this cost of the smaller down payment loan is large enough, it can outweigh the high rate and lack of deductibility of other debt. Consolidation makes sense only if the cost of the larger mortgage that consolidates other debt is lower than the combined cost of a smaller mortgage without consolidation plus the other debt.
To know the costs, you must shop for two loans: the larger loan where you consolidate, and the smaller one where you don’t. A new calculator I developed with Chuck Freedenberg of DecisionAide Analytics, available on my web site, allows you to compare these costs over the period you expect to remain in your home -- assumed to be 5 years in the example below.
Let’s assume a purchase price of $200,000; interest rates of 8% on a $190,000 loan for 30-years with 5% down, 16% on $10,000 of other 10-year debt that you want to consolidate, and 9% on the $200,000 zero down payment loan that consolidates the other debt. Lets also assume you are in the highest tax bracket, 39.6%. The largest cost is the payments made during the 5 years. If you don’t consolidate, the payments on the $190,000 mortgage plus the payments on the other debt total $106,203.
If you do consolidate, total payments amount to $109,439, or $3,236 more. The impact on payments of reducing the interest rate on the $10,000 of other debt from 16% to 9% is outweighed by the increase in rate on the other $190,000 of the consolidated mortgage from 8% to 9%. These payments include lost interest -- what you could have earned had you invested the payments at 5%. While lost interest does not materially affect the results in this example, it can be an important factor if the two mortgages differ primarily in their upfront costs rather than in their interest rates.
An offset to these costs is tax savings, including the interest earnings on tax savings. Assuming a tax rate of 39.6%, tax savings are $33,375 if you don’t consolidate, and $39,674 if you do. Consolidation generates $6,299 more in tax savings. A second cost offset is the reduction in loan balances over the 5 years. This amounts to $12,480 if you don’t consolidate, and only $8,240 if you do, a difference of $4,240.
The larger pay down in debt when you don’t consolidate reflects the lower interest rate on the $190,000 loan and the relatively short term on the other debt. Pulling it all together, net costs would be $1,177 lower if you don’t consolidate. The mistake is to decide in advance that you are going to consolidate, and only shop for a mortgage that allows it. If you shopped only for the $200,000 no-down payment loan in the example, consolidation might appear very attractive because it reduces the rate on the $10,000 of consolidated debt, from 16% to 9%, and makes the interest on that debt deductible as well. Ignoring the higher rate you are paying on the other $190,000 would result in a costly mistake.
On the other hand, consolidation might well pay if the rate on the larger mortgage was lower. The consolidation calculator shows a "break-even rate" of 8.825%. Any rate on the larger mortgage below that would make consolidation profitable. The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com Copyright 2000 Jack Guttentag Distributed by Inman News Features
