Ask Chuck: Cash-out refinance advice

Dear Chuck,

My home is in need of multiple costly repairs. My neighbor just did a major update on his home, and he told me he did it with a cash-out refinance. We also need a new car. What should we do? 

Refi Home  

Dear Refi Home, 

There is a lot in your question that I hope I can assume correctly and give you some solid advice.  

I must assume you are free of all consumer debt and have built your emergency savings fund to three to six months of your current living expenses. Also, I assume your car is paid for and you will not borrow money from your equity to buy a new car. Getting out of debt and having emergency savings are higher priorities than doing repairs on your home or buying another car, and these are certainly not things that I recommend that you borrow against your home to achieve. With that aside, let’s talk about what you may be able to do with a cash-out refinance. 

Bankrate.com says homeowners pulled $70 billion in equity from their homes in cash-out refinances in the third quarter of 2021. It was the highest rate in over 14 years.  Back in ’07, the housing bubble was about to burst, holding many vulnerable to foreclosure. Borrowers last year had higher credit scores and pulled cash at a third of the rate of ’07. Higher home values reflected lower loan-to-value ratios. It’s led to the lowest total market leverage ever recorded, with the average borrower’s mortgage debt at just 45%. This is a sign of the inflation in real estate values that we are experiencing.   

Refi advice

Rates are on the rise, so if you hope to lock in a decent rate, you need to act quickly. 

I recently recommended a cash-out refi for one of my sons. His historic home needed a new roof and some interior work. Because he is an Army veteran, he was able to get a fantastic rate with no closing costs. His property has appreciated, so his refi provided enough cash to cover all repairs at a lower mortgage payment. It was a complete win for his family. 

A traditional refinance involves retaining a financial institution to trade your existing mortgage for a new one at a better rate. With a cash-out refi, you borrow more than your remaining mortgage balance and convert equity in the form of a check or wire transfer to your bank account. In other words, you pull equity from your home to use for the repairs.

There are pros and cons with the length of the loan. A 30-year note offers lower monthly payments but a greater interest rate and higher total costs over the life of the mortgage. A 15-year note will cost less in the long run but has higher monthly payments. Decide on the length of loan that serves you best. Just remember: the shorter the term, the better the rate. 

Careful use of funds 

A cash-out refi makes sense if you need some money for home improvements or repairs. Using your mortgage to get a new HVAC or roof may be the cheapest money you’ll find. If you want to update kitchens or bathrooms, research what brings lasting value. Be mindful of resale potential for your area. Increasing the home’s market value will add to your home equity. My rule of thumb is to always use the funds to put back into your home to protect its value. Avoid using your home equity as an ATM for your impulse spending or lack of self-control. 

Using a cash-out refi to pay down private student loans at high rates makes sense, but not on Federal loans with reasonable interest rates. Using your equity to invest in your career can be beneficial. On the other hand, don’t refinance for cash to go on vacation or buy consumer goods. Instead, find ways to increase your income or decrease expenses. You could also do a simple refi to get a lower payment which would enable you to pay down debt. Some financial pros say that cash-out refi can be wisely used to boost retirement savings if placed in a diversified portfolio. For most people, pulling out home equity to invest is a risk that I don’t advise taking. By all means, don’t use it for day-trading or buying volatile stocks like crypto. 

Dangers of a cash-out refinance

• Risk of foreclosure: A larger home loan can increase your mortgage payments. Never take out more than you can comfortably cover because you could fall behind in payments and lose your home. 
• Closing costs: Costs vary by lenders. Make sure you understand all charges in order to accurately compare and assess quotes. 
• Overspending cycle: Paying off high-interest debt with low mortgage rates makes sense if you have self-discipline to avoid repeating your mistakes. Control your spending, and manage your finances wisely, or you could end up in the same predicament in the future. 

Some other considerations involve how long you plan to stay in the home and whether you have a prepayment penalty on your mortgage. If a larger loan reduces your equity to less than 20%, you may have to pay private mortgage insurance (PMI). Avoid this. 

If you already have a low mortgage rate, a home equity loan or line of credit may serve your purposes. Whatever you choose to do, proceed with caution. Do your research on the lender, the terms of your note, and the costs involved. Most of this is available online or by asking your lender for full disclosure documents. Read all the fine print. Ask questions. Don’t assume that you are not vulnerable to being ripped off. Seek wise counsel and pray for wisdom. God gives it generously (James 1:5).

We have several Crown Stewardship Podcasts that you may find beneficial. Some of our recent ones include preparing for inflation, finding relief from debt, and lowering expenses while increasing faith.