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  Dear
Dr. Don,
I'm considering paying off my 10-year, 5.49 percent
fixed-rate second trust mortgage, originally $49,000 and taken out
in late April 2004 (with a current loan balance of about $45,000),
and transferring the balance to a credit card, which will involve
raising my credit limit, to obtain a 1.99 percent fixed-rate, four-year
loan.
The higher monthly payment will put us at a 24
percent monthly debt ratio, before taxes. What are the implications
concerning my credit score and concerning this higher unsecured debt?
I believe both of these loans are simple interest loans, and not "front-end
loaded" with interest payments. Is this a good move? Thanks!
-- Rick Refi
 Dear
Rick,
It's probably not a good move. Read that credit card offer carefully.
A fixed rate on a credit card agreement can be a fairly nebulous
agreement. I would be surprised to find the company offering a guaranteed
fixed rate over the four-year life of the loan. Purchase requirements
and how payments are allocated to account balances can also influence
the amount of interest you pay.
The credit agreement may also stipulate that
if you are late on any bills, the loan provider can (and will) increase
the interest rate on your loan. So review the offer to know what
the triggers are and assess your ability to continue to meet the
loan terms over time.
Are you using the mortgage interest deduction on your
income taxes? By switching from mortgage debt to unsecured debt,
you'll lose that interest deduction. If you're in the 25 percent
marginal federal income tax bracket, the after-tax rate on your
mortgage loan is 4.12 percent vs. 5.49 percent.
Does the second trust loan have a prepayment penalty?
This type of loan often does and that would make paying it off less
than one year into the loan an expensive proposition.
Although there's a big difference in the interest
rates, the difference in loan terms also has a lot to do with the
total interest expense. The table below shows an approximation of
your current situation and two alternatives. Assuming there is no
prepayment penalty, if you can afford a $976/month payment on the
credit card loan, you can afford to make an additional principal
payment on the mortgage loan. By doing so, you shorten the term
of your mortgage loan to 4 1/3 years. You still pay $3,803 more
in interest than the credit card loan, but preserve a mortgage interest
deduction if you use it on your taxes.
| d |
Credit card loan |
2nd trust mortgage |
2nd trust mortgage
+ additional payment |
| Interest rate |
1.99% |
5.49% |
5.49% |
| Loan balance |
$ 45,000 |
$ 45,000 |
$ 45,000 |
| Loan term (months) |
48 |
110 |
52 |
| Payment |
$ 976 |
$ 494 |
$ 976 |
| Total payments |
$ 46,852 |
$ 54,380 |
$ 50,655 |
| Total interest |
$ 1,852 |
$ 9,380 |
$ 5,655 |
| Difference |
d |
$ 7,528 |
$ 3,803 |
Your credit score probably would suffer by
switching the mortgage balance over to credit card debt because
you've increased the ratio of debt outstanding to debt capacity
on your unsecured credit lines. The front
ratio and back
ratio that are calculated on a mortgage loan don't make any
difference if you're not applying for a mortgage.
A company is offering to loan you $45,000 for
four years at an interest rate that is below the current 2.25 percent
rate target for fed funds, in an interest rate environment that
is expected to go higher. I don't care how good your credit is,
as an individual you shouldn't be able to borrow at that rate. So
you have to look at how the firm expects to benefit from your loan.
Find the answer to that and you'll be better able to decide if you
want to restructure your debt this way.
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