Cash-out Refi = 30 Year Car Loan!?

11/5/2005, 10:11 pm

Back in August of 2003 I blogged about the best way to refi: “In my opinion and if you can afford it, an ideal refi is one in which you only refinance the remaining balance on your current mortgage, retaining for yourself the equity in your home.”

Imagine that instead of refinancing only the remaining balance and retaining the value of your equity, you do what most people do and pull out cash. It’s called a “cash-out refi” and some wrong-headedly think of it as “free money”. (Hint: It isn’t!)

Every dollar you pull out of your equity by doing a cash-out refi, is a dollar you’ll repay with interest. Consider this scenario:

Your home originally cost $125,000. During the time you’ve owned it you’ve paid down your mortgage so that you now owe $80,000. And since you bought it, your home has appreciated in value so the current value is $160,000. In this scenario, you have $80,000 in equity.

Your current loan carries a 9.5% interest rate and your lender offers you a 6.5% rate on your refinancing. But wait! The lender is happy to tell you they will loan you a lot more than the remaining balance. They encourage you to consider a cash-out refi, “use the value of your home to do something special like buy an SUV or a boat!”

Stop! First, ask yourself “Why are they pushing money at me?” Second, ask yourself, “Do I really want to throw away my equity?” Third, ask yourself, “Do I really need a boat?” Then, think clearly about your options.

1. You can stick with what you’ve got. You’ve already made 241 payments of 1051.07. You have 119 payments left for a total amount remaining to be paid of 125,077.33. You’ll be “home free” so to speak in less than 10 years.

2. Choose to refinance only the remaining balance. A simple refi of $80,000 at 6.5% would cost you $505.65 per month for 360 months for a total cost of $182,034. You’ll save $545.42 per month on your monthly payment but you’re adding 20 years of additional payments. Because of these additional 20 years of $505.65 per month, you’ll pay $56,956.67 more for your house than if you stick with what you’ve got.

3. The most expensive option is a cash-out refi. If you cash out and refinance your $80,000 balance and pull an additional $50,000 out of your equity your total loan amount will be $130,000. At 6.5% for thirty years your monthly principal and interest payment will be $821.69. Your monthly payment is $229.38 less per month than your current mortgage loan, but you’ll make that payment each month for 30 years (and you’ve currently got less than 10 years left on your current loan.) Your cash-out refi will cost you $295,808.40 over the next thirty years.

And the boat you bought with the $50,000 you pulled out of your equity will cost you a total of $113,770.80 over the thirty year term of your cash-out refi. Chances are pretty good, you’ll want another boat much sooner than you’ve paid off your 30 year refi loan. (Or maybe you want the SUV … don’t they depreciate to near zip in less than a decade?)

Again, an ideal refi is usually one in which you only refinance the remaining balance on your current mortgage, retaining for yourself the equity in your home and avoiding the risk of lossing your home for a boat or SUV.

Do your own math with Real Estate Calculator Suite

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