Real Estate and Finance

Cash-out refinancing may sound great but can turn into a costly mistake

After years of making regular mortgage payments, it feels good to watch your net worth make upward progress. That is especially true if your house is also gaining value. With a growing amount of equity comes peace of mind, knowing you have the option of tapping into it when you want.

Whether it is time for a new roof or you need to consolidate debt, you may see a traditional cash-out mortgage refinance as the ideal tool to access the money you need. However, if you are considering a cash-out refi, you may be unaware of some of the pitfalls, or you may not know about the alternative solutions that might work in your financial favor.

With a cash-out refi, homeowners can borrow against the equity in their home by taking out a new mortgage loan. This new loan includes the original loan balance and the additional amount borrowed against the equity.

“On the surface, a cash-out refi loan appears to be the better option because these tend to have better interest rates compared to other types of loans, especially credit cards and personal loans,” says Wendy Harrington, chief marketing officer at Figure Technologies, a company that offers lending solutions to homeowners. “However, these can end up costing more than homeowners expect, and it’s important to take time to understand what comes with the territory.”

Harrington explains three things all homeowners need to consider before they opt for a cash-out refi loan:
Interest rates are fluctuating: After enjoying historical lows, mortgage interest rates have recently approached 5 percent, the highest in eight years, according to the Washington Post. With a cash-out refi, homeowners face trading their lower interest rate for a higher one.

Less convenient than other loan products: The application and approval process for a cash-out is anything but efficient, thanks to time-consuming activities like property appraisals and in-person closings. In all, the loan process can take anywhere from 30-60 days.

Additional fees: Borrowers often don’t realize that cash-out refis come with closing fees for such things as appraisals, title searches and credit reports, adding another layer of cost to the loan.

A smarter solution that can potentially spare borrowers thousands in interest cost, according to Harrington, is a home equity loan. Instead of starting over with a new mortgage, you’d simply take out a separate loan against the equity in your property. This option lets you keep your mortgage interest rate.

To make things more clear, here’s a comparison of how the two loans could affect a homeowner like you.
Let’s say you took out a $175,000 mortgage six years ago at 3.625 percent interest. After making monthly payments of $798, your balance is $153,365. Now you are looking to do some renovations and pay off some credit card debt, and you need to borrow $75,000. With your home valued at $300,000, there’s more than enough equity.

With a cash-out re-fi loan, you would “reset” your mortgage balance at $228,365 with an interest rate of, say, 5.75 percent interest. That brings your monthly payment to $1,333, but in 30 years, when the mortgage is paid off, total interest comes to $287,225 (that’s the interest you paid on your original mortgage and the interest you’ll pay with the refinanced loan).

With a $75,000 home equity loan, you may receive a higher rate, but it applies to a much smaller loan amount. If you secured a home equity loan at 9.0 percent APR, your monthly payment for your mortgage and equity loan combined would be slightly higher at $1,559. However, the term of your equity loan is 15 years, and your mortgage is still on track to being paid off in 24 years. In all, your total interest payments come to $174,238 (original mortgage plus home equity loan).

Bottom line: In this scenario, a home equity loan comes out as the better financial decision, because not only would you finish paying six years earlier, you would save $112,987 in interest alone.

Home equity loans maybe be available for 5, 7, 10, and 15 years at a fixed rate.

If you’re looking to access the equity in your house to help you complete a home improvement project or consolidate your bills, taking time to know your options can potentially save you thousands of dollars. Figure has built a calculator to show how much you could save using a Home Equity Loan PLUS instead of a cash-out refi. Calculate your potential costs and savings at