Personal Loans Are Stealthily Refinancing Credit Card Receivables. Are Mortgages Poised To Do The Same To Personal Loans?

Mortgage ‘Cash-Out’ Refinance as a % of Total Mortgage Refinance

The benefits of using an unsecured personal loan to consolidate credit card debt is quite well established. An entire industry (LendingClub, Prosper, Avant, Marcus by Goldman Sachs among other traditional Banks) is flourishing in this space and helping consumers reduce their interest rates on revolving credit balances by refinancing the same into a fixed term installment loan.

The typical loan – a ‘debt consolidation’ credit purpose transaction, results in a personal loan of about $15,000 taken out at an average rate of 12.5% for 60 months with a 5% origination fee (except for loans issued by banks) used to pay-off revolving credit card debt often at rates much above 18%. This example is summarized as below:

The finance charges (payment of any fees and interest over the life of the loan assuming it is held to maturity) for this personal loan (using the above terms) is $5,998. Assuming a discount rate of 10%, the time-value adjusted finance cost is $5,166 in this scenario.

For homeowners, would it make sense to consider refinancing this personal loan into their existing mortgage? Are there any significant benefits of doing so?

Assuming the consumer has $15,000 in equity in his home, and without paying any additional refinancing costs such as mortgage insurance premium (for Conventional Loans, the maximum permissible cash-out loan to value is 80%, for FHA loans it is 85% and VA loan holders are allowed to take additional loans up to 100% of the appraised value of their homes) a comparable table that captures economics of the personal loan refinanced through a 30 year fixed rate mortgage is as below:

Assuming a discount rate of 10%, the present value of the finance cost is $4,560 in the above example.This is slightly lower than $5,166 for a personal loan. Any additional financial benefits such as earnings from re-investing the $265 monthly savings in cash-flow are excluded from this calculation.

Do the advantages of refinancing credit card debt (or for that matter a personal loan originally taken to refinance credit card debt) using a mortgage outweigh the benefits of doing the same with a personal loan? Some of these advantages include:

• Significantly lower monthly payment
• Lower finance charges in present value
• Tax deduction of mortgage interest
• Among other aspects

Cash-Out Refinance transactions can also be taken for credit purposes other than debt consolidation. Just like personal loans, home improvement is the next most common credit purpose for cash-out refinance. However, a majority of the loans offered by personal loans originators is primarily for debt consolidation– given that most home improvement expenditures can be financed using in-store credit cards.

While Cash-Out Refinancing is at its highest levels (49% of total Refinance) since the financial crisis as per Freddie Mac’s May quarterly research release, it is still much below the peak levels seen during earlier home price boom cycles.

Consumers are not yet fully cashing out on this opportunity. What is stopping them from doing so? Some factors include:

Awareness of ‘Cash-Out’ mortgage refinance product

Refinancing a mortgage is often associated with reducing rate or changing term, also known as ‘Rate and Term’ refinance, which is the most prevalent and popular refinance transaction. A ‘Cash-Out’ refinance is less known of and only comes into the limelight when interest rates move up sharply and there are fewer Rate and Term refinance opportunities.

Convenience of transaction

The time required to consummate a cash-out refinance can take anywhere from 30 to 50 days as an appraisal is mandatory to determine the value of the house and estimate equity in the home. Comparatively, a rate and term refinance need not always require an appraisal (VA IRRRL’s, FHA Streamlines or HARP programs) and can can be completed in under 21 days. This is still quite a lengthy process as compared to unsecured Personal Loans for debt consolidation that can be obtained in as little as 48 to 72 hours!     

Home Price Appreciation and awareness of the same

Consumers continue to recover from the housing crisis shock and the sharp home price decline, often unaware of the home price recovery that has gradually happened in the last decade and in their own neighborhoods.

Current rate is higher than existing mortgage rate

Homeowners are often deterred from refinancing their existing mortgage because they are locked into a relatively lower rate as compared to the prevalent market interest rate. However, the monthly savings from refinancing high cost unsecured debt may far outweigh the slight increase in rate on the mortgage. Evaluating shorter duration products such as 15 year terms and ARM’s could also make a difference in calculating the economics of the transaction.

Personal Loans Vs. Mortgage Direct Mail advertising   

For the first 6 months of 2017, an estimated 1.3 billion pieces of direct mail advertising was sent to consumers with credit card debt by Personal loans companies!  As a comparison, within the mortgage industry, for the same period, this number is estimated at ~ 300 million mail pieces to refinance (mostly rate and term) their existing mortgages.

The market for unsecured personal loans (debt consolidation) is estimated at $465 Billion. A guesstimate is more than 50% of this market is constituted of homeowners. Could this also be the opportunity size  for ‘Debt Consolidation’ Cash-Out Refinance? Also, given the fact that homeowners have lower credit risk as compared to renters, how is this trend going to impact pre-pays on unsecured installment loan ABS ?

Disclaimer: The views and opinions expressed in this article are solely those of the author. Examples of analysis performed within this article are only examples. They should not be utilized in real-world analytic products as they are based only on very limited and dated open source information.