Dear Dr. Don,
We currently have $40,000 in credit card debt, a mortgage of $141,000 at 6.25 percent and an interest-only equity loan of $68,000. That leaves our home/income ratio at 53 percent and our loan-to-value at 97 percent.
I learned recently that I'll be receiving an inheritance of around $80,000 in the next few months. For us, it's a no-brainer to pay off the hefty credit card balance. However, we're puzzled on how to go about adjusting our home loan/equity payment to make our budget more comfortable and to actually pay down the loans. We plan to live here for the next two to three years.
Should we try to refinance at a lower rate and sink the remaining $40,000 into it? Or should we just lock in our equity loan interest and pay down $20,000 in principal while investing the rest?
What's the best way to set ourselves up for financial and real estate success?
-- Roxanne Requests
Rather than one right answer, you need to find the answer that's right for you. Your letter reads like it's more important to free up some funds in your monthly budget than it is to try to minimize your total interest expense.
I'll suggest three possible plans for using the extra $40,000 wisely:
Plan A: Recast your mortgage. Along with paying off your credit cards, you could ask the first mortgage lender to recast your mortgage. The $40,000 lump sum payment will allow you to reduce the monthly mortgage payment without incurring the closing costs of refinancing. Not all lenders are willing to recast a mortgage.
Plan B: Pay down balance on interest-only mortgage. Since you don't plan on being in the house for long, refinancing isn't likely to make sense if you can't recast your mortgage. Therefore, paying off the credit cards and paying down the balance on the interest-only loan makes sense. That assumes there's not a prepayment penalty on the interest-only loan.
Plan C: Invest the extra money. Alternately, you could pay off the credit cards and invest the other $40,000, drawing against it only as needed to provide some breathing room in your monthly budget. Paying off the cards should free up a nice chunk of change in the budget. Plan C has the benefit of preserving a measure of financial flexibility.
You need to reflect on how your credit card balances got this high. Paying down the balances only to have them ramp up again over time will get you right back to the situation you're in now, only with no inheritance to rescue you from your past spending.
Although I prefer to call it a spending plan rather than a budget, Bankrate's home budget calculator can help you lay out your monthly income and expenses.
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