A growing number of homeowners who are refinancing their
mortgages want more than a lower interest rate—they want a little extra cash. In
a cash-out refinance, borrowers can withdraw equity from their homes at the
same time as they alter the interest rate on the mortgage. The transaction
typically gets more popular when home values rise, as newly confident borrowers
look for a way to cover home repairs, reduce debt or pay expenses such as
college tuition or travel.
But homeowners should make sure that they aren’t digging
themselves too deeply into debt, which could haunt them down the road if, for
example, home prices fall. And they should consider whether other alternative
moves might accomplish the same goal at a lower cost.
Lenders completed 243,847 cash-out refinances in the third
quarter, up 32% from the prior quarter and up 6% from a year ago, according to
exclusive data from Black Knight Financial Services, a mortgage data and
services company. Cash-out refis accounted for 31% of all refinancing activity
in the third quarter, compared with 18% a year ago, according to Black Knight.
That was the highest share since the fourth quarter of 2008.
The move can be a convenient way to get extra spending
money. Banks say some homeowners are also opting for a cash-out refi to pay off
a home-equity line of credit, or Heloc. Payments on Helocs are often interest-only
for the first 10 years, before principal payments are also due. The move can
make sense if you refinance into a fixed-rate mortgage, because interest rates
on Helocs are typically variable, so borrowers could get hit hard if those
rates rise.
But be aware of the risks. Borrowers who fall behind on
credit-card payments don’t risk losing an asset, while borrowers who fall
behind on home loans risk foreclosure. Take particular caution before using a
cash-out refi to fund a vacation or another big-ticket purchase. Don’t forget
closing costs, which are typically 2% of the loan amount on a refinancing.
Another factor to consider: Borrowers who are 10 years into
paying down a 30-year mortgage and refinance into another one will once again
be making the early payments, which mostly go toward interest charges. To pay down principal faster, ask lenders to
make the new loan for a shorter term. Many borrowers hesitate to take out a
15-year loan because it often comes with larger monthly payments. But most
lenders offer 20- and 25-year options.
Consider taking out a Heloc or a home-equity loan, instead.
The interest rates on these loans are typically higher. But because the amount
borrowed tends to be smaller, borrowers typically pay less in interest charges
than they would on a mortgage. Also, Heloc borrowers only incur interest
charges on the amount they draw down. And closing costs on Helocs can be under
$200, and sometimes cost nothing, he says. On home-equity loans, closing costs
can be up to about $1,000.
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