Vail Daily column: Good debt vs. bad debt
February 5, 2016
Under the right set of circumstances, I am not opposed to increasing the loan amount on a particular mortgage. In some instances, I recommended that clients borrow as much as they are able, per lending guidelines and equity requirements. This may contradict much other advice. But when it comes to analyzing what I refer to as good debt vs. bad debt, the recommendation is easily justified and explained.
It is best to understand early what I mean by good and bad debt. Debts, or credits that pay high interest and are not tax deductible, are what I refer to as bad debt. This debt could be identified as high interest credit cards or personal loans. In many circumstances, the borrower is simply trying to make the minimum payments each month.
Good debt would be classified as a mortgage. As of right now, the mortgage interest that is paid annually is the only interest that is tax deductible, assuming the debt is against a primary or secondary residence, which is a tremendous tax advantage. I assume that the interest rate on the particular mortgage is under 4 or 5 percent, which is extremely low, further classifying a mortgage as good debt.
There could be another type of credit or debt that is not necessarily classified as good or bad debt. Auto loans can still be found with very low interest rates. Or perhaps a credit card with an introductory 0 percent interest rate. While the interest — if there is any — paid on these type of loans is not tax deductible, the rates are generally low enough not to classify them as dangerous or bad debts.
Reducing Risk of Bad Debt
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For the right set of circumstances, I am absolutely in favor of increasing a mortgage loan amount or taking out more mortgage debt, if it will help eliminate high interest non-tax-deductible debts. Accomplishing this can occur in a few ways. If the borrower already owns a home, then he or she can look at refinancing the mortgage in place and taking additional equity, assuming there is sufficient equity to do so in the transaction, to pay off the bad debt. The borrower can elect to pay off the credit card debts directly at closing or receive the equity in the form of a check and do so himself or herself, post-closing.
If the scenario is a purchase transaction, then the borrower could elect to put less money down on the purchase. By doing so, the borrower would leave excess funds available to pay down debt. Doing so could put the borrower in a more advantageous financial position as he or she enters into owning the home.
There is no doubt that a mortgage is no longer simply a loan used in order to purchase a home. Residential mortgage loans are a complex financial instrument. Increasing the loan amount in the course of refinance transaction or putting less money down on a purchase transaction, in order to eliminate bad or expensive debts, is a complex financing analysis. Doing so is certainly not advisable for every borrower or every scenario out there. However for the right borrower and circumstances, this can be a key move in one's overall financial security and well-being.
As with any mortgage financing in the current environment, the advice and counsel of a seasoned mortgage professional needs to be sought.
William A. DesPortes of Central Rockies Mortgage Corp. can be reached at 970-845-7000, ext. 103 and firstname.lastname@example.org.
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