A cash-in refinancing could put your savings to better use
If you've got a stash of cash earning 1% or less in certificates of deposit and money market accounts, there’s a way to get more out of your savings.
Pay down your home loan through a cash-in refinancing.
The combination of a lower mortgage rate and smaller balance could dramatically reduce your monthly payments and save you tens of thousands of dollars in interest costs.
It also helps to build equity in your home faster, boost your net worth and create greater financial security for you and your family.
Lots of people have been doing cash-in refis recently.
According to Freddie Mac, 39% of homeowners who refinanced in the last three months of 2012 paid down their balance at closing.
Only 16% of borrowers took equity from of their homes through a cash-out refinancing.
Of course some homeowners have to reduce the balance to swing a new loan because they don't have enough equity in their homes to qualify for a mortgage.
But for many of those households, it's a move that makes a lot of financial sense. Consider this example of how cash-in refis work.
Let’s say you bought a $300,000 house in 2006 with a $240,000 mortgage carrying a 6.5% interest rate. Your monthly principal and interest payment on that loan is $1,517.
Six years later, the value of your home has since depreciated to $225,000, but you still owe about $220,000.
You're not underwater, which is where you owe more on your home than it is currently worth, but you're close. Too close to qualify for a conventional loan.
Most banks will refinance a home loan for no more than 80% of the home's current value -- or a maximum of $180,000 in this case.
To close the deal you'd have to come up with the difference to pay off the old loan, or about $40,000.
Is it worth it? Depending on your personal situation, that investment could pay you back many times over.
If you refinance into a new $180,000, 30-year, fixed-rate loan with a 4% interest rate, the principal and interest payment will be about $859, or some $658 less each month than you’re paying on your old mortgage.
It will take you about five years to recoup your $40,000 investment, not counting any closing costs you’ll have to pay.
But look how much you'll save over the life of the loan.
If you keep your original loan and don’t refinance, you’ll have to pay another $216,000 in interest until the loan is fully paid off in 2036.
If you do the cash-in refinancing, you'll pay $129,365 in interest.
By investing in a refi now, you’ll realize savings of more than $86,000 in interest over the next 30 years.
You’ll save even more by taking out a shorter-term, 15-year mortgage.
Interest rates on those loans are currently around 3%, so the monthly payment on a $180,000 loan would be $1,243, or about $274 less than you’re paying in our example.
Plus, you’ll have the mortgage paid off in nine fewer years. Total interest savings: more than $170,000. Not a bad return on a $40,000 investment.
It’s critical that you meet the requirement of having 20% equity in your home.
Home equity reflects that portion of its value that belongs to you, not the lenders. (It's the current value of the home minus the remaining balance on all mortgages divided by the value times 100).
Even if you find a bank or mortgage company willing to refinance your loan with 5% or 10% equity, it will require you to buy private mortgage insurance (PMI) to protect the lender in case you default.
That can wipe out much, if not all, of the interest savings you may get by switching to a lower-rate mortgage.
You also need to be fairly certain that you will stay in your home for at least as long as it takes to earn back your cash-in investment, plus closing costs.
But if you meet those criteria, doing a cash-in refi may be one of the smartest investment decisions you can make.
Before you decide, read our 6 smart moves for refinancing now.
Then use our mortgage calculator to find out how much you could save.
You’ll need to know how much you owe on your current mortgage, your monthly payment and interest rate, the approximate value of your home, how much money you can expect to borrow on a new loan, and the approximate interest rate and maturity on the new loan.