Will refinancing solve all my problems?

Don Taylor

Dear Dr. Don,
We got a $328,000 loan for our new house a year ago at 8.5 percent with a prepayment penalty if we sold or refinanced in the first two years. I got this loan in my name only because my husband's credit is not that good. My credit score when I got this loan was about 700.

We have about $14,000 in credit card debt and can't save much money because we are paying off these debts. Some of this debt is "no payment, no interest credit" so I'm trying to pay them off as soon as I can. Out of the $14,000 debt we owe, $7,000 is in my name ($5,000 is under the "no payment, no interest" and will come due January 2005; $2,000 is on an American Express card, which I'm paying monthly).

I was thinking of refinancing the loan. By doing so, we can pay off all our credit and can even cash out to start a business. Is it worth paying the prepayment penalty if we got a good rate (say, 6.5 percent)? Our house value has gone up by $100,000 or more.
Aileen Alternatives

Dear Aileen,
Don't muddle the issues between refinancing and paying the prepayment penalty, getting cash out to consolidate your credit card debt and taking cash out to start a business. Look at each issue separately and if it stands on its own merits, then you can consider restructuring your debt or taking on additional debt.

If rates stayed the same over the next year, and you could get the same 6.5 percent rate a year from now, then it would be clear cut that you shouldn't refinance now and pay the prepayment penalty. Since no one knows where rates will be a year from now, you have to decide if spending almost $14,000 in prepayment penalties plus closing costs on a first mortgage makes sense today.

Bankrate's refinancing calculator will show you how many months it will take for you to recoup your prepayment fees and closing costs. I input the information you provided and estimated $5,000 in closing costs and the calculator showed that it would take 40 months for you to break even on the refinancing. It can make sense if you plan on staying in the house for the next 30 years, and you expect mortgage rates to stay higher over the next five years. Don't do it if you don't think you'll be in the house much longer than the point where you recoup your costs.

The debt restructuring to pay off your credit card debt can be accomplished with a home equity loan, and you wouldn't have to pay the prepayment penalty. The same is true for cash out for the new business. Choosing between a variable-rate home equity line of credit and a fixed-rate home equity loan when interest rates are expected to head higher is a difficult decision, but Bankrate's Mortgage Adviser worksheet can help you determine which is better for you.

I'm a little concerned that you're having trouble putting money aside now when one-third of your credit card debt doesn't currently require a payment. Debt restructuring will switch your unsecured credit card debt to secured mortgage debt. When you have trouble meeting your mortgage payments, you risk foreclosure. You haven't stated how much money you need to get started, but the additional cash out will add to your budget pressures.


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