Cash-out refinances are back despite rising interest rates. According to Freddie Mac, the number of cash-out refinance mortgages are near 2007 levels – in the last quarter, 81 percent of all refinances were for a larger amount than the original mortgage and the average refinance rate ended up being higher1.
For many, a cash-out refi can appear to be the best option because rates are fixed and seem lower than other equity-out options. However, if you actually dive into the numbers, there are big reasons to not give up a low, fixed-rate mortgage to cash out equity.
There are other ways to take equity
Understanding that most people need the money for something – home improvements, debt consolidation, tuition, or something else – we’re not suggesting that people shouldn’t take cash from their home. Rather, we want people to know that there are smarter ways to do it. Both home equity loans and home equity lines of credit allow homeowners to withdraw cash from equity in their home, much in the same way they would using a cash-out refinance. The Figure Home Equity Line combines the best aspects of both loan options. It’s a fixed-rate solution that provides full access to your funds up front and also allows additional draws once you pay down your original loan.
Giving up a low APR can be a bad move
In a recent Wall Street Journal article, a homeowner reported being happy to refinance because she was able to take out $75,000 in cash to make improvements to her home and pay off some credit card debt even though she gave up her 3.625 percent interest rate for a 5.75 percent rate.
Let’s dig into a similar scenario so you can understand how these details affect Jane’s overall financial outlook. Jane purchased a home six years ago for a little over $200,000. She got a loan for $175,000 at 3.625 percent. Today, she’s paid off a little over $21,000 (her loan balance is $153,365). Her home is worth $300,000 and she's looking for $75,000 in cash to do home renovations and pay off some credit cards. Currently she pays $798 a month for her mortgage and has paid $35,827 in interest to date.
A cash-out refinance is one way to withdraw funds. If she went with this option, Jane would get a new 30-year mortgage for $228,365 (old mortgage balance + cash out amount) at 5.75 percent. Her monthly payments will be $1,333, but because she is spreading a larger amount of debt over 30- years, she’ll end up paying $287,225 in interest alone.
A Figure Home Equity Line is another option. Jane could keep her existing mortgage and get a Figure loan for the $75,000 she needs for improvements and debt. Even if this loan has a 9.0 percent APR, she’ll end up paying less over time. Jane could take a 15-year Figure loan for $75,000. Her monthly payment will be higher, $1,559; however, she'll only pay $174,238 in interest (mortgage + Figure Loan). That's $112,987 in interest saved!
Refinancing drags out debt
Using a Figure Home Equity Line could help homeowners pay off debt faster. If Jane, from the above example, chose to use a Figure Home Equity Line over a cash-out refinance, she would pay it off in 15 years and pay off the rest of her mortgage in 24 years. A cash-out refinance, on the other hand, would potentially start the 30-year clock at zero, stretching a larger amount of debt over a longer period.
Mortgage closings cost more
Mortgage closing costs range from two to five percent of the total loan amount2, and homeowners have to pay these fees every time they finance or refinance a mortgage. If Jane’s closing costs and fees amounted to three percent of her loan, she would have already paid $5250 when she first purchased her home, and she’d likely pay an additional $6,851 when she refinanced.
Home equity loans aren’t free – they have closing costs similar to mortgages. A Figure Home Equity Line only has an origination fee, which ranges from zero to three percent. However, even with a three percent origination fee, Jane would only pay $2,250 to take the same cash out with the Home Equity Line. If you weren’t already counting, that’s a potential $4,601 difference in closing costs.
Cash-out refinances are a great option if a homeowner can lock in a lower rate on their mortgage, but that is becoming increasingly unlikely, as the Fed has raised rates three times this year, and future hikes are expected. If you are thinking about a cash-out refinance, be sure to look beyond the offered APR and consider the long-term impact of interest on your financial health. See how much you could save using a Figure Home Equity Line instead of a cash-out refi here.1 http://www.freddiemac.com/research/datasets/refinance-stats/index.html