Q&A - Estimating Loan Consolidation

 

Topic:  Cash & Debt Management, Consumer Issues

Q:  How do I estimate savings by consolidating all our loan into one? I would like to refinance the mortgage and also roll in car loan and a home equity loan. Current mortgage has 10 more years, car loan at 4 years, home equity at 4 years. How should I evaluate the savings, since I would essentially be stretching out the home equity and the car loan?

A:  First, Ask Our Experts (AOE) would not encourage you to stretch your existing car payments over the term of a new mortgage and has mixed feelings about stretching out the home equity loan.  Without knowing your precise objectives for rolling these into a new home mortgage, AOE is not inclined to advise you against it, only to caution you that doing so would likely increase your overall interest cost on these obligations even though the new mortgage rate may be quite a bit lower than the current interest rate on these loans.  Unless your goal is to bring your monthly payments to an absolute minimum, we would encourage you to structure a plan of extra mortgage payments that would serve to pay off these other debts by the same date they would be paid off if you didn't refinance.  Let us illustrate using some hypothetical numbers.  You can substitute your own to arrive at the right monthly payment amount in your case.

 First let's make some assumptions about your current debt

Current mortgage:  Balance $100,000, Rate 7.5%, Payment $1,187.02, matures in 10 years
Current HE loan:   Balance  $15,000, Rate 8.5%, Payment   $   369.72, matures in 4 years
Current auto loan:  Balance  $12,000, Rate 9.9%, Payment  $   303.78, matures in 4 years
Total:                    Balance  $127,000, Payments $  1,860.52

Now let's assume you roll all these debts into a new $127,000 first mortgage at 5.5% for 15 years. 
Your minimum monthly mortgage payment will be $1,037.70, providing you with the opportunity to reduce your monthly debt service payments by a whopping $822.82.  But doing so would result in your taking 15 years to pay off a car that will probably be in the junkyard much sooner.

So, using an online mortgage calculator, calculate what payment it would take to pay off these shorter-term obligations in the same time.  We used the calculator at Interest.com (http://www.interest.com/cgi-bin/financial_new.cgi), but there are many available and they all do pretty much the same job.  Going through this quick exercise yields the following payment amounts for the components of the new loan amount:

To repay the current first mortgage amount in 10 years, payment needs to be $1,085.26
To repay the current HE loan in 4 years, payment needs to be $348.85
To repay the current auto loan in 4 years, payment needs to be $279.08
To get all debts paid off by current maturity dates, initial monthly payment should be $1,713.19.  In other words, you would need to make additional monthly payments of about $675 ($1713.19 - $1037.70 = $675.49).

While your monthly payments are reduced by only $147.33 initially, that entire savings is interest savings.  After four years, you could reduce your monthly payments by  $628 since the car loan and home equity loan will have been "paid off".

There is an income tax element to this problem that we have ignored here because it's pretty insignificant.  The tax benefit you realize currently on your first mortgage and home equity loan interest payments will be reduced because the interest cost is reduced.  But this will likely be offset (at least for the first four years) by converting the interest on the auto loan to deductible mortgage interest.