It’s no secret that mortgage rates aren’t cheap anymore.
In the first quarter of 2022, you can still get a 30-year fixed premium in the 3% range.
Within a year, interest rates rose by 8%, before falling in 2024 to about 6% and then rising again to 7% in the run-up to the election. It’s been a wild ride.
Today, the 30-year interest rate is about 7% for your typical loan scenario, but it can be higher for some transactions like a cash-out refinance.
To make matters worse, the typical homeowner already has a very low rate, so losing it could be a big mistake.
A cash-out refinance pays off your existing mortgage
Recently, I’ve heard firsthand more stories of people struggling financially. The financially good days of the pandemic are now in the rearview mirror.
There are no more incentives and prices for almost everything are much higher than they were a few years ago.
Whether it’s a homeowners insurance policy or even a trip to your favorite fast food restaurant, Prices are not your friend now.
This may have forced you to start relying on credit cards recently, racking up debt in the process.
Perhaps you are now looking for a way to ease the burden and reduce interest expenses.
After all, credit card APRs are also through the roof, with typical interest rates topping 23% for those actually assessed interest, according to Federal Reserve.
Obviously this is not ideal. No one should pay rates that high. This is a no brainer.
So it would be wise to cancel the debt one way or another or lower the interest rate. The question is what is the best strategy?
Well, some loan officers and mortgage brokers are offering cash-out refinances to homeowners with high non-mortgage debt.
But there are two major problems with this.
You’ll lose out on your lower mortgage rate in the process
When you apply for a refinance, whether it’s an interest rate or term refinance or a cash-out refinance, you lose the old rate.
Simply put, refinancing pays off the old loan. So, if you currently have a mortgage with a mortgage interest rate of 3% (or maybe even 2%), you will deposit it in the process.
This is obviously not a great solution, even if it means paying off all your other expensive debt.
Why? Because your new mortgage rate will likely be much higher, perhaps in the 6% or 7% range.
Sure, that’s less than the 23% rate on a credit card, but it will apply to your entire loan balance, including your mortgage!
For example, let’s say you qualify for an interest rate of 6.75% on a cash-out refinance. This doesn’t just apply to the cash you withdraw to pay off those other debts. This also applies to your remaining home loan balance.
Now you have a larger outstanding mortgage balance with a much higher mortgage rate.
Let’s say you originally took out a loan amount of $400,000 at 3.25% interest. Your monthly payment will be approximately $1,741.
After three years, the remaining loan balance will drop to about $375,000. Well, I’ve made some progress.
If you refinance and withdraw $50,000, your new balance will be $425,000 and your new 6.75% payment will be $2,757!
So now you’re paying another $1,000 a month toward your mortgage.
But wait, it gets worse.
Do you want to pay off those other debts over the next 30 years?
Not only did your monthly payment jump by $1,000, but you also consolidated your mortgage debt with your non-mortgage debt.
Depending on the term of the new loan, you may be able to repay it over the next three decades. This isn’t entirely ideal.
Some lenders will allow you to keep the current loan term, 27 years in our example. Others may offer a new term of just 30 years.
Either way, you’ll pay off those other debts much more slowly. If you try to deal with them separately, you’ll probably be able to cut them down a lot faster.
And remember, your mortgage payment is $1,000 higher per month. This money could have gone toward other debts.
Even if your new mortgage payment is less than your combined monthly refinance payments, it may not be ideal.
A better option may be to take out a second mortgage, such as a home equity line of credit (HELOC) or a home equity loan.
Both options allow you to maintain your low first mortgage rate while also leveraging your equity to pay off other debt.
Interest rates must be within the cash-out refinancing rate range. Maybe higher, but say something like 8% or 9%, instead of 6.75%.
Most importantly, This higher rate will only apply to the cash portionnot the entire loan balance as with a cash-out refinance.
So, yes, a higher interest rate on the $50,000 balance, but still 3.25% (using our previous example) on the much larger balance, which would result in a much better blended interest rate.
This does not reset your current real estate holding, allowing you to stay on track to meet your return goals.
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