Cash-out Refinance

Considering the options of cash-out refinance against a second mortgage

There are many debtors who are scared at the thought of not being able to repay the mortgage, since this could lead to the loss of their collateral, which in most cases would be their home, one of the most prized assets for anyone. Hence they look at the other available alternative options like the debt consolidation refinance or a mortgage refinance. While making the decision on which of the many options should be used as an alternative financial solution in lieu to protect the mortgage, the most important factor to be considered is the long term benefits the solution will bring and the additional costs that will be incurred for exercising this option. While the basic thing to be considered is to see whether the new mortgage has an interest rate which is lower than your existing mortgage, you can also see the other options like debt consolidation loans which are cheaper and help reduce the installment amounts. There are plenty other things to consider which may help you to finalize the option that is the best for you and some of the main ones are as follows:

• The rate of interest and the points offered in the second mortgage as compared to the same costs of the existing first mortgage. This comparison will help you to find if taking the second mortgage will provide you with any profits and benefits or not.
• If there was mortgage insurance on the first mortgage, and if there is no requirement to have a mortgage insurance requirement on the new mortgage, then the savings on that front should be considered as a part of the cost differences.
• The tenure of the new mortgage while considering the interest rate and period of remaining term of the existing first mortgage should be compared to see the impact on whether the tenure or the overall costs got reduced or not.
• Along with tenure, you should also see the amount of money that needs to be paid as a part of each installment, and see if your budget can support the amount requirements of the new mortgage or not.
• The other non-apparent factors like your income-tax bracket, expected duration of time that you expect to continue living in the current home and the rates of interest you can earn on savings should also be considered while evaluating the refinance options.

There are a lot of websites which provided free or premium services which allow for the calculation and comparison of the different refinance options. These calculators use all of the above mentioned factors and come up with all costs and options, also showing the expected earnings and installment amounts for a future time period based on the assumptions of the debtor. Using these tools can help to find on how to breakeven on the second mortgage and avail the best possible deals making the refinance option lucrative.

However, one thing that needs to be kept in mind is that the options for the second mortgage are less costly if they are available at interest rates which are below the breakeven rate, and hence good research needs to be done before taking a plunge. Let’s consider an example so that the explanation makes sense.

Consider that a debtor has taken a loan of 100,000 dollars at 7 percent rate, before 2 years without needing mortgage insurance for tenure of 30 years, and he needs another 50,000 dollars in mortgage now. For getting this money, he has 2 options, he can either refinance the existing mortgage or he can get a second mortgage of 50,000 dollars. We can consider that the payment falls under the highest income tax bracket and hence is charged at 39.6% with the investment earnings of about 5%. Based on these calculations, the home would now be worth 213,000 dollars. Considering that the insurance would continue for the next 5 years, a period of time when the debtor is expected to remain in the home, the two options may get valuations which are as follows.

If the insurance would continue for the next 5 years, which the debtor expected to remain in the home, then the new first mortgage would be for 30 years at 8.25%, along with one point. And thereafter the second mortgage would be about $50,000 plus costs, for 15 years at 11.5% and one point. Based on the above calculations the break-even rate on the second mortgage would be about 18.25 percent and would have a market rate of 11.5 percent for the second. Hence over the period of the next ten years, the cost of the second would be 11,361 dollars less than refinancing the first.

In the second example, the same calculations are there except for the fact that the debtor would be able to afford a 15-year term on the new first mortgage cash-out. In this case, the break-even rate, for the second would be 16.86%, and the savings on the second would drop to $8,982.

In the above cases, the borrowers who acquired the mortgages a few years ago would have got rates which were significantly below the current market rate, and so they were better off taking a second mortgage instead of refinancing the first. However, if the debtor has had older mortgages with higher interest rates, then doing the refinancing would make more sense as compared to taking a new mortgage.

If you get a mortgage refinance deal, it can be used to ensure good tax savings as well. Now, while it is true that the other important thing to be considered here is that the older you get, the more difficult it is to obtain a mortgage with a longer lease, and hence when you are in the prime of your career, say in your 50s, you will fall prey to high tax rates and since your mortgage is just about finished, you won’t be able to write off the taxes as well. But, if planned properly, and you would have applied for a mortgage refinance in your 40s, and taken some money out of the equity, you could have increased the mortgage on your home and then used this higher mortgage as a tax reduction in your future.

The important point to be remembered is that the situations, the amount of mortgage and the financial situations of different debtors are different and hence the factors which govern their interest rates, insurance options and late fines, should be considered properly before deciding which of taking another mortgage or refinancing the first mortgage is more beneficial to them. Moreover, the whole process does take some time and hence refinance cannot help you if you are in need for cash overnight.

Updated: Jan 7, 2011 10:47