Beware the Cash-Out Re-Fi
This has been a good news week for homeowners looking to re-finance their mortgage loan into a lower rate. Mortgage interest rates fell sharply this week following more rescue actions by the government. The average interest rate for a fixed 30-year mortgage loan dropped to under 6%, a seven week low. Mortgage loan re-financing activity has already picked up. Unfortunately, re-financing a mortgage loan also creates a substantial risk that the borrower will end up with a larger loan balance.
Even more risky are “cash-out” re-financings where the lender offers to increase the loan amount by $5000-$20,000 or more, thereby putting this extra cash into the pockets of the borrower to spend. Too many homeowners wrongly see this as “found money” and give in to the temptation. They do not stop to calculate how much they will actually be paying for this “found money” over the life of the loan.
The hard truth is that taking cash out of a re-finance transaction is rarely a good idea and often defeats the purpose and benefit in securing the lower interest rate. A mortgage loan re-finance should not be viewed as an opportunity to increase your overall debt load.
Mr. ToughMoneyLove suggests that mortgage re-financing should be focused on reducing the term of the loan and consequently lowering the total interest paid. In other words, if you can shorten the amortization term of your loan from 30 years to 15 years while keeping the before and after monthly payments close (because of the lowered interest rate), that is a solid reason to go for the re-finance.
If you want to run some re-finance comparison numbers yourself, Bankrate.com has a re-finance calculator that can help you.
So take advantage of this interest rate gift that the government has provided. But if you decide to re-finance, please resist the temptation to take cash out of the deal. That new kitchen or exotic vacation can wait until better economic times are upon us.