Today's relatively low interest rates are driving not just a homebuying frenzy but a refinancing boom as well. Refinancing is up 192% according to the Mortgage Bankers Association. Refinancing is simply replacing a current home loan with a new one. Some of the homeowner's accrued equity can be factored into the new loan and turned into cash.See If I Qualify
In a previous article we explored three good uses of a cash-out refinance:
- Get one of today's attractive low interest rates.
- Fund home repairs or improvements.
- Replace an unpredictable adjustable-rate mortgage (ARM) with a more comfortable fixed-rate mortgage.
Good reasons for a cash-out refinance do not end there. Here are two more ways the cash from a refi can be put to good use, plus one terrible way you should put out of your mind right now.
Pay Off Expensive Credit Card Debt
Once you get used to seeing mortgage interest rates in the high 4s and mid-5s, it's shocking to realize how high average credit card interest rates are at the same time. Mortgage rates are driven by a variety of factors, such as the economy, Treasury bond rates, and housing demand. Credit card interest rates, in contrast, are driven by greed.
Sorry, you card companies, but there's really not a better or nicer explanation for it. There was a global pandemic going on, you might have noticed, yet the whole time, the interest you were charging your cardholders remained sky-high.
The average credit card interest rate today is 20.65% according to data collected by The Balance¹. Compare that to the 5%-6% rate of a home refinance, and you see why paying off credit cards is a good use of a cash-out refi.
Everyone's goal should be to carry no credit card balances from month to month. Use the cash from a refinance to pay off (not just pay down) credit card debt. You must still keep a card in your wallet for such purchases as hotels and airline tickets, but pay off the bill entirely when it comes.
If you divide debts into good and bad, credit card debt definitely falls on the bad side.
47% of Americans are carrying credit card debt, and 23% of cardholders have added to their credit balance as a direct result of the COVID-19 pandemic.CNBC
Now we come to the next good use for a cash-out refinance.
Refinance, Then Pay Off Your Home Faster
On the topic of dividing debt into good and bad: What's an example of good debt? The loan that allows you to be a homeowner, for one. Every dollar you pay toward the principle of your home loan makes you that much more a homeowner.
The injection of cash into your bank account from a cash-out refinance can put you on stable footing to make very smart, long-term moves with your money.
Let's say you have used the cash to escape egregiously expensive credit card debt (congratulations!). Now instead of sending money to credit card companies in an arrangement they have designed to last forever and line their pockets, you make your mortgage payment and build equity. The interest rates were so much more favorable on the refi than the credit cards that you save a few hundred dollars every month. What to do with that extra money?
Look at the surprising savings you get by paying as little as $100 extra on your mortgage principle each month.
$200K home loan at 4.5% APR. Monthly payment $1,013.
|LOAN PAID IN…
|TOTAL INT. SAVED
|Minimum ($1,013) every month
|$100 extra every month
How great that some of the equity you built up in your home can be cashed out to free you from the terrible credit card trap and pay off your home loan faster! A bad debt vanquished and a good debt shortened. That is a smart use of a cash-out refinance.
Ask your lender how you can ensure that the extra money goes 100% toward the loan principal, not the interest. Look at your monthly statements to make sure it happens. Only the money you pay toward the home builds equity.
Refinancing at a lower, fixed rate allows millions of borrowers to save money in this pandemic. One caveat: If you’ve been laid off or furloughed, qualifying for a new loan can be difficult. Also, closing costs can be steep, so do the math.
A Terrible Use of a Cash-Out Refinance
For many Americans their home is their single biggest investment. Your equity represents how much of the home you actually own; the bank owns the rest. One sweet day you will own it all.
A terrible reason for a cash-out refinance would be so you can blow the money like you just won it on a game show. After the transitory pleasure of that splashy purchase or Instagramable vacation, you are left owing more on your home for years and years.
Resist the temptation to think of your home equity as an ATM, even if that's the imagery in the bank advertisements.
In our two articles we have given you a total of five good reasons for cashing out some of your equity at today's attractive low rates, but treating the money like a windfall is definitely not one of them. If you don't make sensible choices to use the money from a cash-out refi, you are better off leaving the money in equity.See If I Qualify