Cash out with a refinance?

Q – If Mortgage Rates drop and I can take some equity out with a refinance and still have a lower payment, is that a good or bad financial decision?

A – While it might look good on your budget sheet, there are several reasons not to do a “cash out refi” as it’s called. First, the refinance resets the loan length clock. Maybe you had a 30-year loan, and did this refi at the 2-year point, essentially extending the total length of the time to pay off the house to 32 years. Second, all debt is a risk, even though we all borrow to own a home. What if you lost a job, became disabled, or had some other family emergency down the road and couldn’t easily make the payments? Extending the length of the loan doesn’t help. And third, what are you doing with the cash out from the refi? If it’s on wasteful spending, then that money is gone forever, and you’re left with a higher debt. If you say you’re going to invest the money to make a higher return than the mortgage interest rate, remember that investment returns aren’t guaranteed, while the mortgage is, so again, you’re increasing financial risk.

Definitely consider refinancing as a way to pay less total interest for all your debts OR to get to a better financial position. If you can shorten from a 30-year to a 15-year loan and have the same, only slightly higher payment, that’s a win. But, don’t refinance to 15 years and have a much higher payment (even if you’re approved) and put yourself in a budget bind every month. This is the kind of decision that I like to run through calculators and then think through a bit.

What do I mean by a "better financial position' by refinancing? Say the rates drop, and you cash out $25,000. You can pay off the last two years of a car loan, put $10,000 toward a new 25-year roof, and add $8,000 to an almost non-existent emergency fund, for a little less loan payment. You'll also be able to up your retirement savings due to the elimination of the car loan payment, which is even more of a win in my book.