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Pulling Cash Out

A “cash-out” refinance can change the rate and/or the term but instead of simply paying off the old mortgage, you walk away with some extra cash that was pulled from your equity. Most cash-out refinances allow you to refinance up to 75 percent of the value of the condo and even up to 80 percent of the value if you pay a 1/4 percent higher. The higher LTV option at 80 percent rarely works out when you consider the additional funds that are combined with the higher interest.

Let's look at a cash-out example at 75 percent and 80 percent, with a $200,000 value and a current loan balance of $100,000. We'll leave out closing costs in this example to keep the math a little easier.

At 75 percent LTV, the loan amount would be $150,000; and at 6.25 percent the payment would be $948. Subtract the $100,000 old loan, and the net is $50,000.

At 80 percent LTV the loan amount would be $160,000, and the payment would be $1,011 per month with the higher loan and higher rate. The net is $10,000 more, but your monthly payments are $63 higher. That yields another $22,600 or so in additional long-term interest.

Cash-out refinances can be good, but they must be executed with eyes wide open. If you just need some extra cash for home improvements or to pay off a car note, get an equity line instead. Equity lines have little or no closing costs. If all you want is $50,000, then consider an equity line instead of refinancing with all the associated costs. Only do a cash-out refinance if you're going to refinance anyway, due to rate or term.

Loan officers get trained to scour through old loan applications or make slick mailers touting the advantages of a cash-out refinance. They may look at one of your old loan applications, see that you had a car loan and some credit card debt, and send you a note saying you could save lots of money with a cash-out refinance. You'll rarely get a sales pitch from loan officers wanting to place an equity line with you because they don't get paid much, if anything, on an equity line.

The phone call might go something like, “Hey Dave, just checking in on you. Say, I was reviewing some old files and saw that you have a couple of car payments that add up to about $1,200. You know, we could refinance your current loan and although your rate won't go down a whole lot, we could pay off those cars and it'd save you a bundle, not to mention that now the interest on the car loans would be tax deductible because the loan is mortgage interest and not a consumer loan!”

The loan officer has already run the numbers before he calls you and yes, he's right: Your total monthly payments would drop. Here's the scenario:

Current mortgage balance


Current rate


Current payment


Current car balances


Current rate


Current car payments


House and car payments


New mortgage balance


New rate


New payment


You just traded a $2,497 payment in for a $1,615 payment. Common sense (and plain arithmetic) tells you that you saved $882, right? At first glance it appears so. But the difference between an auto loan and a 30-year mortgage is about 25 years. Yes, your payment dropped, but the auto payments would have gone away after less than five years.

In less than five years you would still own the car, but you would no longer have to pay the automobile loan. Today your monthly payments are $318 higher while you make the car payments. Say you consolidate and pay off the car loan today. How long before you sell or trade for a new car — and take on a whole new set of auto loan payments?

Cash-out refinances are not bad things. But you need to be fully aware of both the short- and the long-term effects of pulling out additional cash.

Another cash-out “pitch” is to refinance the loan, pull as much cash out as you can, and then invest the difference in stocks or bonds — or perhaps entrust those funds to an investment adviser your loan officer happens to know (and exchanges leads with).

When you are solicited to pull out cash it's usually in the loan officer's interest, not in yours. Those sales pitches and marketing gimmicks can be pretty convincing, so beware.

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