Why You May Want to Avoid a Cash-Out Refinancing Right Now Loaner

It’s no secret that mortgage rates are no longer cheap.

In the first quarter of 2022, you could still get a fixed 30-year maturity of around 3%.

In one year, rates reached 8%, before dropping in 2024 to around 6% and then rising to 7% as the elections approach. It’s been a crazy adventure.

Today, the 30-year rate is around 7% for your typical loan scenario, but can be even higher for certain transactions like a cash-out refinance.

Worse yet, the typical homeowner already has an extremely low rate, so losing it could be a big mistake.

A cash-out refinance pays off your existing mortgage

Lately, I’ve been hearing more stories of people struggling financially. The easy money days of the pandemic are behind us.

There is no more stimulus and prices on almost everything are much higher than they were a few years ago.

Whether it’s the home insurance policy or even a trip to your favorite fast food restaurant, prices are not your friend right now.

This may have forced you to rely on credit cards more recently, thereby accumulating debt.

And maybe now you’re looking for a way to lighten the load and reduce your interest costs.

After all, credit card APRs have also exploded, with typical interest rates topping 23% for those who are actually charged interest, according to the Federal Reserve.

This is clearly not ideal. No one should pay such high rates. It’s obvious.

So it would be wise to eliminate the debt in some way or reduce the interest rate. The question is what is the best strategy?

Well, some loan officers and mortgage brokers offer cash-out refinances to homeowners with high-rate non-mortgage debt.

But this poses two major problems.

You will lose your low mortgage rate

When you apply for a refinance, whether it’s a rate-and-term refinance or a cash-out refinance, you lose your old rate.

Simply put, a refinance results in paying off the old loan. So if you currently have a mortgage with a 3% (or maybe even 2%) mortgage rate, you’ll be saying goodbye to it at the same time.

Obviously, this is not a good solution, even if it means paying off all your other expensive debts.

For what? Because your new mortgage rate will likely be much higher, perhaps around 6 or 7%.

Sure, that’s lower than the 23% rate on a credit card, but it will apply to your ENTIRE loan balance, including the mortgage!

For example, let’s say you qualify for a 6.75% rate on a cash-out refinance. This doesn’t just apply to the money you withdraw to pay off these other debts. This also applies to the remaining balance of your home loan.

You now have an even larger mortgage balance at a significantly higher mortgage rate.

Let’s say you initially took out a $400,000 loan at 3.25%. Your monthly payment would be around $1,741.

After three years, the remaining loan balance would drop to approximately $375,000. Okay, you’ve made progress.

If you refinance and take out, say, $50,000, your new balance would be $425,000 and the new payment at 6.75% would be $2,757!

So you are now paying $1,000 more per month on your mortgage.

But wait, it’s worse.

Do you want to pay this other debt for the next 30 years?

Not only did your monthly payment jump by $1,000, but you also combined mortgage debt with your non-mortgage debt.

And depending on the term of your new loan, you could pay it off over the next three decades. It’s not really ideal.

Some lenders will allow you to keep the duration of your current loan, 27 years in our example. Others might propose only a new 30-year term.

Either way, you’ll pay off those other debts much more slowly. If you just tried to tackle them separately, you might be able to narrow them down a lot faster.

And don’t forget that your mortgage payment is $1,000 higher per month. This money could have been used to pay other debts.

Although the new all-inclusive mortgage payment is lower than the combined pre-refinance monthly payments, it may not be ideal.

A better option might be to take out a second mortgage, such as a home equity line of credit (HELOC) or home equity loan.

Both of these options allow you to keep your first mortgage rate low while tapping your equity to pay other debts.

And interest rates should be within the withdrawal refinancing rate limit. Maybe higher, but let’s say something like 8% or 9%, instead of 6.75%.

Above all, this higher rate would only apply to the withdrawal partand not the entire loan balance as would be the case with cash out refinancing.

So yes, a higher rate on the $50,000 balance, but still 3.25% (using our previous example) on the much larger balance, which should result in a much better blended interest rate.

And it doesn’t reset the clock on your existing mortgage, keeping you on track to meet your repayment goals.