The Dangers of Cash-Out Refinancing
Borrowers are tripping over themselves to pull cash out of their homes. When that happens — and few borrowers realize this — they are generally paying a higher rate than their old mortgage to be able to make that withdrawal.
Here's how a cash-out refinance works. You have a $300,000 first mortgage on a home that's been appraised at a value of $500,000. You want to rehab your kitchen, and you see that yummy $200,000 in equity just sitting there. You get a bid of $50,000 for the kitchen, leaving you with $150,000 of net equity in your home.
Yes, you'll probably get stuck with a higher rate on the overall loan, but it's probably still cheaper than a home-equity line of credit or a home-equity loan.
I think rates are going down, and I want an ARM. What shouldI check out first?
Just remember that no one can be 100 percent sure of where rates are going. A big part of the recent debacle in the mortgage industry was adjustable-rate refinance loans with suspicious pricing. Make sure you fully understand the loan that's being proposed for you.
Yet once people try refinancing once and pay off a big expense with the cash proceeds, turning equity into cash can be habit-forming. And that's why the statistics on refinancing have gotten so huge.
If you're considering refinancing to extinguish debt, it's really important not to do a quick fix with home equity unless it's really necessary. It's much better to put yourself on a short credit leash and then try and pay off your existing debts in cash.
