Wise and Not So Wise Refinancing Choices

With homes steadily and rapidly appreciating for several years, refinancing is alive, well, and regularly making news. A blast form the past - cash-out refinancing peaked in 2006, when homeowners cashed out $320.5 billion in total home equity volume, according to Freddie Mac’s Cash-Out Refinance Report. Then the bottom fell out of home values sending many mortgages underwater resulting in practically no home equity being available to draw cash out of.

Freddie Mac refinance statistics only represent a portion of the total market activity. With that in mind, Freddie Mac estimates that $61.2 billion in total home equity volume was cashed out during 2016. The first quarter of 2017 cash out estimate is $14.0 billion. Of that, it’s estimated that 49 percent did not increase the loan amount but rather took advantage of lower interest rates to lower mortgage payments or shorten the number of remaining years on the loan. Another 49 percent did result in an increase in the loan amount indicating borrowers pocketed cash. The remaining 2 percent resulted in a lower loan mount.

Many Cash Options

The average homeowner gained about $13,400 in equity between the first quarter of 2016 and the first quarter of 2017 along with more equity accumulating since late 2014 when values reversed course from depreciating to appreciating. Cashing out that equity can be spent in almost any manner. Here are some pros and cons of the most common uses of cashed out equity.

Home remodeling is among the most popular. The hope of many people is that a renovation will increase the value of the home. However, reality is that you are better off renovating with the goal of making your home more attractive and more functional for your own needs. According to Review Remodeling magazine, the average bathroom addition pays back slightly less than 60 percent of the total cost. The exception is if you add a second bathroom to an older single bathroom home. A $50,000 kitchen remodel may please you as a gourmet cook but it won’t likely add nearly that much to your home’s value.

If you can’t afford a fancy new car on your existing income, it’s probably not financially wise to cash in your equity to buy it. Unlike your home, the car will almost certainly depreciated rather than increase in value. In fact, you aren’t even likely to save on the interest rate since most new car loans cost less than home equity loans or lines of credit. The same goes for other high-end luxuries like boats and RVs.

Paying off credit card debt and taking big vacations have also been common choices for cash out refinancing. Reality is that you’ll be financing that vacation for the next 20 or 30 years with a new mortgage. Even worse, too many consumers just run credit card debt back up to new highs after credit limits are increased following the refinancing pay off.

College and Real Estate Investing Make Some Financial Sense

Rehabbing to flip another house or becoming a landlord can be ways to use your equity to increase your wealth. But first, be sure you have the skills and knowledge to be successful. Among the many financing options are taking out a new mortgage secured by the investment property or refinancing your primary home to pay cash for the investment. Taking out a separate mortgage comes with a higher interest rate and is more difficult to qualify for compared to refinancing your own home.

Investors are more likely to default on an investment property than their primary mortgage. Therefore, lenders typically demand a higher interest rate and a high down payment. Investing with all cash by refinancing can be a good choice as long as the higher monthly payment on your own home doesn’t jeopardize losing your primary home to foreclosure.

Financing your children’s college education is a combination of emotional and financial prudence. On the upside, home equity loan rates can be less than other college loans along with the paid interest on a home equity loan being tax deductible. On the downside, you put your home on the line for your children’s education. When the children take out college loans, these often come with flexibility during times of financial hardship. Federal student loans are eligible for loan deferments, forbearance, and sometimes even loan forgiveness.

Cash-out refinancing is one of many ways you access your home’s equity. Just be sure you learned your lesson from the housing downturn and Great Recession. Home values generally rise but can also fall dramatically and might not be your wisest financial move.

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Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for eleven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.