A cash-out refinance can cost you big

Pink piggy bank with trail of coins to a house

A cash-out refinance -- assuming you have the equity -- might seem like a good short-term solution when you don't have enough money to pay for a major expense.

It's easy, interest rates are low and mortgage interest is tax-deductible.

But how will cashing out impact your finances in the long run?

Before we get to that question, we should note that cash-out refis are at a 16-year low, a reflection of the large decline in home values. Just 18% of homeowners who refinanced last quarter tapped into their equity.

But if you have equity built up, here's how to uncover your total costs: Use the amortization schedule on our mortgage calculator.

First, calculate what you’ve paid in interest so far on your current mortgage. Add to that the interest you will pay on the new loan to get your total borrowing cost to pay off the house and the cost of cashing out.

For example, consider a $200,000, 30-year, fixed-rate mortgage at 6% that you’ve had for five years.

Our mortgage calculator’s amortization schedule shows that you’ve paid $58,056 in interest and your principal balance is now $186,108.71.

We're making some assumptions with this example that you have more equity than what you've built up through mortgage payments. We think it would be wise to keep at least 30% equity in your home after taking cash out.

But let's assume you grab a new 30-year, fixed-rate mortgage for $200,000 at 4.25%. (That's roughly today's average rate on 30-year home loan.)

Under this scenario, you'll be adding about $14,000 to your mortgage.

Our mortgage calculator’s amortization schedule shows that if you keep this loan until you pay it off, you’ll pay a total of $154,197 in interest over the life of the loan. The total cost to borrow the $200,000 to pay for your house is $212,253 (combining interest paid on both the original and the new loan).

If you didn’t take any cash out and instead only borrowed $186,109, the total interest on the new loan would be $143,487, and your total cost to borrow the $200,000 would be $201,543.

Calculate the difference between the total interest paid under each scenario, and you’ll see that cashing out costs you an extra $10,710 in interest.

Even if you get some of that money back in the form of a lower tax bill, you’re still looking at a steep borrowing cost.

Whatever you’re going to spend that $14,000 on will actually cost you about $25,000.

That's not worth it.

Paying almost double the principal amount to borrow money isn’t a good deal.

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