To Cash-Out Refinance And Make It Rain…. Or Not

Are you thinking about doing a cash-out refinance on your property? First of all, make sure you understand what is involved and how it differs from a HELOC and cash-in refinance for that matter.

Cash-out refinances generally increase during a housing bull market. However, if the real estate market declines, those who cashed out will find their home equity squeezed further.

What Is A Cash-Out Refinance?

A cash-out refinance lets a property owner to use their home mortgage to get additional cash. This mortgage refinancing option replaces an existing mortgage with a new, larger mortgage. The difference between the old and new mortgage amount is paid to the borrower as cash.

What's the catch? A cash-in refinance typically comes with a higher interest rate or more points. Getting a standard “rate-and-term” refinance for the same amount usually has better terms.

The amount you can receive from a cash-out refinance is determined by several factors. The most common determinants are your credit score, the property's LTV ratio (loan-to-value), and your bank's lending standards.

Having lots of cash buys you lots of alcohol, access, and action – Triple AAA if you will. What more does anybody want? With lots of cash, you can also try and buy another investment property.

The Temptation Of Cheap Money Is Strong

Triple AAA tempted me before. I considered doing a cash-out refinance for one of my rental properties at a mortgage rate of 3.375%. If you're in a oppressively high federal income tax bracket, you might consider doing a cash-out refinance. It may lower your income tax bill.

I'm pretty sure I'll be in a lower income tax bracket during retirement (as will you most likely). Thus, I figure why not extract cash out of a rental property. This can 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 was very strong when I was considering doing a cash-out refinance. As a result, 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. 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. Today, this is called your tappable equity, a new term that has started becoming more popular.

Cash-out refinance by generation with Baby boomers having the most home equity

How To Decide Whether To Do A Cash-Out Refinance

1) 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. That said, Treasury bonds are yielding 5% after the pandemic, which is a great risk-free return.

2) 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 housing 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!

3) How disciplined are you with money? 

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.

4) 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?

5) 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.

6 How desperate are you for cash?

The more desperate you are for liquidity, the more it makes sense to do a cash-out refinance. 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. Hence, if you can extra cash from your house, particularly if you are house rich cash poor, then a cash-out refinance may make sense.

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.

Doing A Cash-Out Refinance Is OK 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.

Related post: During Times Of Uncertainty, Take Stock Of ALL Your Cash

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Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible.

For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you're looking for strictly investing income returns. Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It's free to look.

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To Cash-Out Refinance Or Not is a Financial Samurai original post. In general, I recommend not cashing out and trying to keep paying down the mortgage. You'll be glad you did in the future.

29 thoughts on “To Cash-Out Refinance And Make It Rain…. Or Not”

  1. In 2015, I refinanced to a 2.75%, fixed rate 15 year mortgage with a 120K cashout, mainly to invest the money, as I had already refinanced in 2013 at 3.25%. I put all of it in my Vanguard PAS portfolio. With dividends reinvested, I already made over 20K (17%) since then, with a lower rate to boot. the cost was around 2.5K. it was a no brainer.

  2. I am in this situation and just read your post for the first time. Please give me advice. I am in 33% income tax bracket, in Florida no state income tax. We have just under $50k mortgage left on an investment property we just put about $50k in cash flowing a complete reno on it so now it’s value is about $200k. So there is $150k equity sitting there. We were going to sell it, already sat down with realtor…But….should we instead rent it out for $1200/month and break even monthly so I don’t pay income tax on rental income, and do a cash out refi to get that equity in cash?? If I sell, I either have to do 1031 exchange and never touch any cash or I have to pay capital gains tax, ugh. My intent with the cash?…sit around and breathe for a minute and then invest it in something else.

  3. Hilarious intro Sam! I haven’t done one myself but I have heard of them a little. I’d trust myself not to burn through the money shopping but I’m sure I’d be quite tempted to use it for travel and that can add up quick. I don’t think I’d want to do one mainly because the idea of having more outstanding debt just doesn’t feel right and I’m not in a situation where I need a lot of cash right now.

  4. I like the fixer! I agree. Home prices, especially for the high end have been amazingly sticky here in SF and are rising again. Come to papa LinkedIn money before the Zynga money comes!

  5. Personally, I don’t mind having equity in real estate. And you need to consider how much return you could actually garner on the cash out!!! I also try (although not always successfully) to keep things simple.

    1. Yes, the older I get, the more I want to simplify. It’s what makes me not want to expand the real estate portfolio too much, and focus on the simplicity of being online.

      How is SF treating you Barb?

  6. This is a slightly unrelated question. I assume you are in CA and this is a non-owner occupied rental property, right? Do you have earthquake insurance? If not, are you concerned about having a recourse mortgage as opposed to a non-recourse mortgage? If there’s an earthquake that flattens your building, you’re still on the hook for the mortgage, unlike a homeowner who can just walk away.

    1. There’s earthquake insurance. This property has been refinanced multiple times since rates have gone down steadily for 10 years. It was at 5.75% in the beginning!

      I don’t care about recourse since it’s way in the money and the cash flow is very strong. I plan to either hold forever or sell at a profit.

        1. It’s part of the HOA so it’s shared. You thinking of buying a place but seeing high earthquake insurance?

          Definitely calculate all your costa for sure before buying as everything costs money.

  7. Many years ago, I refinanced specifically to take cash to buy another property. I used my equity to build a larger portfolio. Was it wise? Yes! Should everyone do it? No, because of some of the pitfalls you mentioned. Not everyone is disciplined or has a plan. The key word is plan. I planned my expansion and had the discipline to not only do some of these things, but monitor the progress and results. I set up reserves to take care of surprises and I had a history to reflect on to know my risks. Bottom line it worked for me!

  8. Doesn’t make sense to me to borrow money through a 5-year ARM for rental real estate. That implies that you’ll either be selling the property within five years, or have confidence that you can increase rent to keep pace with (potentially) rising rates. That’s a bad deal all the way around.

    Plus, the short-end of the yield curve still isn’t all that attractive from a borrowing standpoint. Might as well borrow where the subsidies are–Bengenie is working far more magic on the long-end of the curve than the short-end. I’d borrow all day on the long-end of the curve at less than 5%, but we have very different retirement horizons, so it’s not really applicable.

    1. You sure about that? I can borrow Libor + at 1.5% now which I’m tempted to do. Dont think inflation is as fast as my 10% rental increase this year, which is on the low end.

      Why would you borrow at the long end and pay 4%? You think rates and inflation are going to jack higher soon?

      1. JT, the 5 yr rate is based on the long bond yield. The LIBOR + margin is for one month floating. Different rates.

        Rates have been going down for 30 years JT. Please look at the historical charts.

        Let me know when you jump into the property market.

      2. That’s why there’s a market. I’ve been right for the past 10 years borrowing on the short end and I’m confident rates arent going higher for the next 3 years.

        Want to make some bets and predictions on the Fed funds or 10 yr yield?

  9. I don’t know if I have enough equity in my rental property yet. But I don’t think I can beat a 4% rate of return anyway.

  10. If my rental has high interest rate + equity, then I would definitely do a cash out refinancing. Assuming I can get lower rate. My rate is pretty low though and the equity isn’t that high. :(
    I’m also not sure if I can do better than 4% in this market.

  11. I like the idea of having the optionality of cash, rather than have it tied up in the property market. If the property market is indeed recovering, then it’s better to take OUT the equity in the form of cash, thereby increase your return on cash (less cash) and use the cash for something else.

    But, if they are going to charge you a higher interest rate, it becomes tougher. It also sounds like a PITA.

    1. That definitely makes sense since the money sitting in property is underutilized money. Just take new debt to increase return on equity is easy. Figuring out how to beat the cost of debt hurdle is hard.

  12. Hey Sam, I agree with your point about “where will you put the money to make a greater return” and make up for the risk your are taking to “cash” out.

    I think I would’ve done what you did, walk away.

    You do sound like the last of the big time spenders on a date…..Those valets must luv to see you coming. vroom vroom!

  13. Money Beagle

    I just did a re-finance. The bank had estimated closing costs and they ended up coming in lower than estimated. They wrote the loan for the original estimate saying that they’d just give me the cash out. I refused and it delayed the closing by a few hours because they had to re-write all the paperwork. It was less than $1,000 but I still felt no reason to take that, especially when I’d made it clear up front that I didn’t want cash.

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