To Cash-Out Refinance And Make It Rain…. Or Not
Lots of cash buys you lots of alcohol, access, and action – Triple AAA if you will. What more does anybody want?
Let’s say you’re on a hot date and roll up in the Corolla to your favorite five star restaurant, Olive Garden. You slip the valet a $5 for the $4 valet fee and tell him to “keep the change” so he can keep it up front.
The hostess greets you coldly and says there’s no table. You pull out another crisp $5 dollar bill and she changes her mind and seats you right away. Normally you just order water, but tonight you get a little crazy with $3 Bud Lights! And afterward, since you two are all tipsy now, it’s Nintendo Wii action all night long!
Now that’s Triple AAA.
THE TEMPTATION OF CHEAP MONEY IS STRONG
Triple AAA is tempting me right now as I consider doing a cash-out refinance for one of the rental properties at 3.375% from 4% (thank you Ben Bernanke). If you’re in a oppressively high federal income tax bracket, you might consider doing a cash-out refinance to lower your income tax bill.
Since I’m pretty sure I’ll be in a lower income tax bracket during retirement (as will you most likely), I figured why not extract cash out of a rental property and increase my interest expense to shield my rental income. With 5-year rental property money at only 3.375%, it would be foolish not to at least consider the option.
The rental market is hotter than the 49ers and I was able to increase my asking rent price by 12% last month from a year ago. My realtor friends implored me to raise the rent by another couple hundred bucks, but I didn’t have the heart since I had already put the price out there on Craigslist, and I found a potentially ideal tenant.
By refinancing, the cash flow for the rental property increased by another 23% for a total increase of 35%. Yet, despite this increased cash-flow, I thought long and hard whether increasing my debt to then negate my cash flow increase was the right financial decision in this low interest rate environment. Doing a cash-out refinance is definitely something to consider if you have a hefty amount of equity in your property.
HOW TO DECIDE WHETHER TO CASH-OUT REFINANCE
* What are you going to do with the money? If you have no good plans for the money that will return at least the cost of your mortgage, then you probably shouldn’t cash-out. CD and savings rates are still much lower than your mortgage rates, so you will be losing money every month you don’t put it to good use. Nothing is a guaranteed return, so think long and hard before plopping that cash down on something that sounds so good.
* What’s your outlook on the property market? If you think the markets are going to tank 90%, then by all means cash out! You don’t want to see your equity disappear. If you can legally cash out and have free cash in your bank account, then please do so before it disappears. In the event of a market crash, it is then up to you to decide whether you should pay your mortgage or not. You should if you live in a recourse state, and maybe not if you live in a non-recourse state. Just don’t brag about it and try and profiteer if you do welch on your debt!
* How disciplined are you? Some people go crazy irresponsible when they have a sudden influx of cash. If you are making say $100,000 a year with $50,000 in savings, could you handle an extra $200,000 in the bank after a cash-out refinance? Would you not be tempted to go on some fancy vacation or buy a car you’ve always wanted? If so, then you shouldn’t do a cash-out refi since you wouldn’t have spent that money if you didn’t get the injection. I have a weakness for nice vacations and cars, even though I haven’t bought one in 4 years and drive a beater.
* How much money are you making? If you already have a high amount of cash-flow or have a a healthy year-end bonus every year and don’t plan to get fired, then perhaps you really shouldn’t do a cash-out refinance. For example, let’s say you want to cash-out $100,000, but you can save $100,000 every year. If this is the case, why bother?
* Understand the rate differential. My banker said I could do a cash-out refinance if I wanted to, but then said my mortgage would have to be re-underwritten, and the rate would go up. Funny how they didn’t tell me this before my appraisal. I was thinking to myself if I borrow more money, I could get a lower rate! Silly me. It’s quite the opposite. This higher rate was the straw that broke the camels back as he tried a little bait and switch. I’m a rate seeker.
* How desperate are you for cash? Interest rates are incredibly low, making living off dividend or CD interest income incredible hard for retirees. Your house is likely your largest asset, which isn’t doing you much good except for providing you a hopefully rent-free place to live. If you are at the point where you have to sell precious belongings, priceless memorabilia, and liquidating your grandchildren’s education funds, then doing a cash-out refinance is a much better option.
A CASH-OUT IS FINE IF YOU ARE DISCIPLINED
Cash-out refinancing is just accounting. You either have cash in the bank or equity in the house. I would actually much rather have cash in hand to do what I want (invest, spend, remodel, travel) than have it stuck in a house which might burn down. Housing will continue to get better over the next 5-10 years. Just make sure that if you do a cash-out refinance that you spend it wisely, preferably on living a better life and investing for more security.
Strong Recommendation: Some of the lowest mortgage rates I’ve seen are by Quicken Loan given they are an online company with low overhead. I know at least 30 people this year who have refinanced through Quicken Loan and with some incredible rates of below 4% for a 30-year fixed and below 2.875% for a 5/1 ARM. I’ve applied before and got matched 2.625% for my 5/1 jumbo ARM! As a result, I’m not saving close to $4,000 in mortgage interest a year. Thank you QE3 and Ben Bernanke!