Expert: Paul Henneman - 7/17/2006

Question
I met with a financial planner to plan for retirement/college expenses for children.  I am 35 and have 2 children 6 and 9.

My planner is suggesting a refin. on my home (owe 73000 APR is 6.25%) Home is worth 240000.  Borrow 176000, set up $5000 emergency fund, pay off $15000 in credit card/other debt and assist with new car purchase ($10,000).  Invest 63000 in mutual funds with approx. 12% return.  Loan is interest only 10/20 term 30 yrs. at 7% with 3 points. I have excellent credit. My question is, is this a wise choice and is this rate any good?  I know all the "low" rates you see can not always be trusted.  Monthly payment will be about $100 less than I am paying now, with all bills.  I do not have any other savings to invest.  Would it be wiser to take out a second mortgage for $90000? even if it is a higher rate?

Thank you for all input.

Frank

Answer
Thank you Frank for your question!
I have a very different take on this than your planner does. I am always against second mortgages, period. In your case, you have built up a great deal of equity with your home. Home values have risen greatly over the past decade, leaving most home owners in this very situation.
But the problem is that most homeowners do what your planner suggests: use that additional equity to finance things like cards, credit card debt, and other general expenses to increase their standard of living. This results in short term, not long term benefits.
Instead, for me, the goal should always be to pay off the house as quickly as possible. Then you have a home and no housing expenses! (other than property taxes and insurance). Imagine your budget if you had no mortgage to pay. By refinancing, you put this off by possibly decades.

This may be not exactly what you want to hear, but instead of using your home equity to pay off credit cards, I would advise re-evaluating your budget to get those cards paid off. For example, you mention a new car. Perhaps this can be put off, and some other short term belt tightening. The goal I would recommend for you is to have that $15,000 in credit card debt paid off in the next few years. Then put all efforts to paying off the house as quickly as possible.

This would put you in a very unique position while still in your 40's: No housing costs, no debt, and decades ahead of most Americans in this regard! You could retire early, or continue to work and save at a vast higher rate.

I do recommend saving for retirement always, as much as possible. If you have a 401k plan at work, you should certainly utilize it. A few hundred a month, or as much as possible, into IRA and other retirement accounts is essential. But using your exisiting home equity is I believe a long term mistake. You will never get out of your home mortgage if you look at your home loan in this regard, there will always be temptations to refinance.

I hope this helps! I would be happy to discuss anything in more detail should you be interested, please do not hesitate to follow up with me.

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
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