Bill (Retired Military) and Jane wanted my help deciding how to get rid of their substantial credit card debt ($170,000+). Their basics:

-Mid 70’s

-Reasonable health/longevity expectations

-Monthly income $7,500 from 2 pensions (3,600 hers; 800 his) and social security and some passive income/RMD’s.

-Home value $1,100,000

-Mortgage balance: $485,000 @$1,500/month; 18 years remaining on a 4.25% VA loan

-Credit card debt service monthly was in excess of $2,800

-Investable assets: 3 IRA accounts ave balance $150,000 each; conservative investor/income needs.

 

What would you advise?

 

Most Loan Officers would urge a VA streamlined loan refi and kick the can down the road another 30 years. The rate for this would be 3.25% so, it is a legitimate refi from that perspective. 15 years would be too rigid, and add an extra drain on already limited income. The real problem was that between the $1,500/mo mortgage and credit card service, they were over 50% of their income and “cat food” was becoming more attractive. By Refinancing at 3.25% and pulling the maximum amount from the refi at the loan close, they would be able to refinance all credit card debt and have ONE monthly bill vs. many bills. (As we age, details like that become more important as every charge is another ball to juggle with many other balls. Think “sensory overload” and you can see how people get into trouble. Their new mortgage payment after the refi would be $3,050 for just principal and interest. Most of that would be interest. Given the tax structure in place today, the mortgage interest deduction would be almost useless. That means the mortgage interest is a true expense without much redeeming value to them.

 

But, what does this solution actually do for the Borrower, and could there be a better solution? The quick answer is “yes”.

In talking with the Clients I heard them several times using the mistaken wording of “paying off the cards” as if they were making the debt go way for the remainder of their lives. Of course, that is absurd. Deeper questions confirmed this, and they were a bit shocked by their own naievety.

While it wasn’t my desire to put them on the spot, it’s also true that sometimes the duty of an Advisor is to compel people to question their thoughts and motives. What they’re really doing is converting debt from one format to another. Short term and unsecured, to long term and secured by their primary residence. That is a BIG difference in structure. In the anticipation of making the financial pain go away, they buried the reality of what they were doing into the hope of living a more relaxed and convenient life. It is true they would be writing fewer checks each month. But, the reality of debt consolidation refinancing in retirement carries a lot of invisible problems that your Clients have a difficult time understanding.

Let’s also review what happens when a mortgage refi pays of credit card debt…

1. Unless you live in a community property state (Hawaii is NOT), when you die, your credit card debt becomes subjective. It is an unsecured debt, and in most cases, the card lender writes it off their books as a loss. UNLESS the Spouse has cosigned for the card or is a joint owner/user of it? The debt will generally die with the debtor. Do you know the one time that is absolutely false? After you refinance and pay off that card. In other words, your surviving Spouse can escape your credit card debts. Add it to the mortgage by refinancing? She’s stuck with the increased principal sum used to convert that card debt to mortgage debt. Only now, she pays for it for the next 30 years, and on half of the income after you die.

2. Debt remediation becomes impossible. Most card issuers will negotiate a settlement for the debt that has a baseline reduction of 50%. I have personally seen card owners call credit card companies on their own and negotiate 80-85% reductions, and saved the fees charged by these national debt management services. Regardless, that option ends the moment you pay the debt off with refi mortgage money. You own the debt, in full, for the next 30 years.

3. The same thing happens in a bankruptcy. Card debt is discharged (generally); unless you refinance it into your mortgage, and then you own it, in spite of your bankruptcy.

 

So, what could a better solution be?

Establish a REVERSE MORTGAGE/HELoC with a lower margin.

Line of credit growth isn’t important and can be addressed with a Hecm to Hecm refinance later when the debt is managed. In Bill & Jane’s case, their $483,000 mortgage is refinanced into a non-recourse mortgage with a HELOC that cannot be cancelled, surrendered, suspended, or reduced in equitable value that is guaranteed to add new equity at the same rate as the mortgage interest rate. The current (adjustable) rate is under the 3.25 VA rate they’re tied to, and it’s NON-RECOURSE. Payments can be diverted to directly address the pain points of ACTUALLY paying off the credit card debt. This frees up $1,500/month that can now be directly applied to the credit card debts in addition to their current effort. There is also approximately $30,000 cash at the close to launch that paydown.

If they want? They had committed to a $3,050/month refi payment to refi the credit cards. Without bankruptcy or renegotiating, they’re done in about 4 years, and can then repurpose the credit card effort to eliminating the reverse, and create substantial tax deductions (Very helpful if they renegotiate their debt balances) along the way. Of course, if they declare BK or renegotiate down, they’re back on their feet in a year or two. Then, they can REVERSE their monies committed to their credit card debt in addition to the $3,050 and make a conglomerate payment against the reverse. Or, invest that money into a dollar cost averaging strategy (granted-this would be better suited for a younger couple) to refortify savings and investment capacities, Insurances, or, “Joie de Vivre”.

Ultimately, living life-that’s what this is really all about.

Additionally, the HELoC feature of the reverse will allow paid in contributions to immediately accumulate (in the actual line of credit) at current mortgage rates. I know most Index Annuity funds are averaging 2-3% per year growth; however, in contrast? The Reverse access is immediately liquid, no transaction costs or surrender charges, does not trigger AMT, federally insured, and not taxable. Also, it allows the borrower(s) to convert some, part, or all of the HELOC balance into guaranteed life tenure income payments that continue until occupancy ends at which time income streams are turned off (a good thing as few people want home equity to subsidize the Medicaid Spend-down rules). These payouts are a double life annuity based upon the date of birth of the youngest borrower, and is structured to be a 150 year access account (vs. Bank 10 yr with 20 yr amortized balance) that is not reduced by the death of a borrower, can be adjusted or suspended at any time for any reason and resumed upon demand, and distributions are based upon the 1958 Commissioners Standard mortality tables…Antiquated distribution pricing that makes the payout remarkably high and flexible compared to purchasing a private annuity.

 

To review, the (moving parts) that make this work would be the Non-Recourse feature of the reverse mortgage, and understanding the status of debt beyond the dollar amount to see how forward refinancing can adversely affect them later in life. In virtually all circumstances, debt refinancing after 62 should be looked at FIRST with a Reverse with a HELOC; NOT the fixed rate; not any other conventional mortgage. If the reverse cannot work? then limit the amount of cash withdrawn and go for it.

 

Another moving part is the mortgage payment itself. Non Recourse allows the Borrower to recommit to the credit card debt without a predetermined schedule. Vacations can happen. Dreams can become goals. Full-time jobs can become part time. Part time can become whatever the Client wants. Equity fixes a lot of problems. People can take a (well deserved) break from 45+ YEARS of paying debt service. Coordination of payments can coincide with quarterly distributions rather than rigidly mandated monthly payments.

 

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