The Latest in Mortgage Trends: Cash-In Refinancing
By Ric Edelman
Does it make sense for you?
For years, the “cash-out refi” was king. Millions of homeowners whose homes had grown sharply in value replaced their mortgages with newer, bigger ones — pocketing tens of thousands of dollars in cash and using that money to make investments, pay for home improvements, buy cars, send children to college and (in some cases) squander on frivolous spending. In 2006 alone, homeowners withdrew $318 billion in home equity, according to Freddie Mac.
Today, the cash-out refi is a memory. It’s been replaced by the “cash-in mortgage,” where homeowners facing big declines in home values, along with huge interest rate increases on their adjustable-rate mortgages, frantically attempt to refinance. But to do so in today’s stricter mortgage environment, they are forced to lower the size of their mortgage — meaning that instead of receiving cash at settlement, they must bring checks with them, often in amounts as high as many tens of thousands of dollars. In the last three months of 2010, says Freddie Mac, almost half of all refinancers brought cash to closing; only $32 billion in home equity was cashed out in all of last year’s refinancings, the lowest amount since Freddie began tracking the statistic in 1985.
Although it might make sense to engage in a cash-in refi if your current loan’s interest rate is high or adjustable (meaning it has the potential to rise), I’m concerned that many people are bringing cash to settlement merely because they want to reduce the size of their mortgage. Emotionally, it feels good to reduce the mortgage balance, but as I’ve pointed out many times, what feels good isn’t always right. (After all, they say heroin feels good, but…).
Let’s say you owe $250,000 on your mortgage. You refinance, bringing $50,000 to settlement so that your new loan balance is just $200,000. Congratulations! Your new mortgage payment is lower than the old one — but it’s still due every month. If you lose your job, face a medical emergency or encounter other financial difficulties, you might find making your new payment just as impossible to do as it was before, with the old mortgage. But if you still had that $50,000 — meaning, if you hadn’t given it to the lender when you obtained your new loan — you would now still have the ability to make mortgage payments for months, even years.
As you can see, it doesn’t matter how small your mortgage balance or payment is if you don’t have the cash available to make this month’s payment.
And that’s just one reason not to prepay your mortgage. For 10 more reasons, check out Chapter 59 of the new 4th edition of The Truth About Money. Read it and talk with your financial advisor before you sign up for a cash-in refi.