It’s no secret that mortgage rates aren’t cheap anymore.
In the first quarter of 2022, you could still get a 30-year fixed in the 3% range.
Within a year, rates were pushing 8%, before easing in 2024 to around 6% then rising again to 7% in the lead up to the election. It’s been a wild ride.
Today, the 30-year stands at around 7% for your typical loan scenario, but can be even higher for certain transactions like a cash-out refinance.
Making matters worse is the typical homeowner already has a rock-bottom rate, so losing it might be a big mistake.
A Cash-Out Refinance Pays Off Your Existing Mortgage
Lately, I’ve been hearing firsthand more stories of folks struggling financially. The easy-money days of the pandemic are in the rear-view mirror.
There’s no more stimulus and prices on just about everything are a lot higher than they were a few years ago.
Whether it’s the homeowners insurance policy or even a trip to your favorite fast food restaurant, prices are not your friend right now.
This may have forced you to start relying on credit cards more lately, racking up debt in the process.
And perhaps now you’re looking for a way to lighten the load and reduce your interest expense.
After all, credit card APRs are also through the roof, with typical interest rates pushing past 23% for those who are actually assessed interest, per the Federal Reserve.
Clearly that’s not ideal. Nobody should be paying rates that high. That’s a no-brainer.
So it’d be wise to eliminate the debt somehow or reduce the interest rate. The question is what’s the best strategy?
Well, some loan officers and mortgage brokers are pitching cash-out refinances to homeowners with non-mortgage high-rate debt.
But there are two major problems with that.
You’ll Lose Your Low Mortgage Rate in the Process
When you apply for a refinance, whether it’s a rate and term refinance or cash-out refi, you lose your old rate.
Simply put, a refinance results in the old loan being paid off. So if you currently hold a mortgage with a 3% mortgage rate (or perhaps even 2%), you’d kiss it goodbye in the process.
Clearly this is not a great solution, even if it means paying off all your other costly debt.
Why? Because your new mortgage rate is likely going to be a lot higher, perhaps in the 6% or 7% range.
Sure, that’s lower than a 23% rate on a credit card, but it will apply to your ENTIRE loan balance, including the mortgage!
For example, say you qualify for a rate of 6.75% on a cash out refinance. It doesn’t just apply to the cash you’re pulling out to pay off those other debts. It also applies to your remaining home loan balance.
Now you’ve got an even larger outstanding mortgage balance at a significantly higher mortgage rate.
Let’s pretend you originally took out a $400,000 loan amount at 3.25%. Your monthly payment would be about $1,741.
After three years, the remaining loan balance would fall to around $375,000. Okay, you’ve made some progress.
If you refinance and pull out say $50,000, your new balance would be $425,000 and the new payment at 6.75% would be $2,757!
So you’re now paying another $1,000 per month toward your mortgage.
But wait, it gets worse.
Do You Want to Pay That Other Debt for the Next 30 Years?
Not only has your monthly payment jumped $1,000, but you also combined the mortgage debt with your non-mortgage debt.
And depending on your new loan term, you might be paying it off for the next three decades. That’s not exactly ideal.
Some lenders will allow you to keep your existing loan term, so 27 years in our example. Others might only offer a new 30-year term.
In either case, you’re going to be paying those other debts off a lot more slowly. If you just tried to tackle them separately, maybe you’d be able to whittle it down a lot faster.
And remember, your mortgage payment is $1,000 higher per month. That money could have gone toward the other debts.
Even if the new all-in mortgage payment is lower than the combined monthly payments pre-refinance, it still might not be ideal.
A better option could be taking out a second mortgage, such as a home equity line of credit (HELOC) or a home equity loan.
Both of these options allow you to keep your low first mortgage rate while also tapping your equity to pay other debts.
And interest rates should be within the realm of the cash out refi rate. Maybe higher, but say something like 8% or 9%, instead of 6.75%.
Importantly, this higher rate would only apply to the cash out portion, not the entire loan balance as it would with the cash-out refinance.
So yes, a higher rate on the $50,000 balance, but still the 3.25% (using our previous example) on the much larger balance, which should result in a much better blended interest rate.
And it doesn’t reset the clock on your existing mortgage, allowing you to stay on track with your payoff goals.
Before creating this site, I worked as an account executive for a wholesale mortgage lender in Los Angeles. My hands-on experience in the early 2000s inspired me to begin writing about mortgages 18 years ago to help prospective (and existing) home buyers better navigate the home loan process. Follow me on Twitter for hot takes.