The popularity of the cash-out refi has jumped to levels not seen in a decade.
In the third quarter of 2016, U.S. homeowners cashed out $17.6 billion worth of home equity, a 66% jump over the same period in 2015, and the trend shows no signs of slowing down.
Why are homeowners suddenly so interested in cash-out mortgage refinancing?
Although mortgage rates have ticked up recently, they are still relative bargains by historical standards. This is giving homeowners a big incentive to pay off their high-interest loans with lower interest cash-out refinancing.
A cash-out refinance involves taking out a new mortgage worth more than the current outstanding balance. You then pocket the difference between the new and old loans.
While there’s reason to believe that most borrowers are using the extra money wisely – to consolidate credit card debt, pay off student loans, and finance home improvements – there are signs that some younger homeowners may be taking unwise risks.
That being said, there are still plenty of reasons that a cash-out refinance makes sense for some homeowners.
Smart Reasons to Cash Out
One of the smartest uses of a cash-out refinance is paying off credit card debt.
With most credit cards charging interest rates of 14% to 18%, and most mortgage lenders charging less than 5% on a cash-out refinance, a lot of money can be saved by replacing credit card debt with a new mortgage loan.
A popular refinance strategy for retiring credit card debt involves paying all open credit cards down to $0, then using the monthly savings to reduce the new loan’s principal balance.
By doing this, homeowners can potentially save hundreds of dollars a month while reducing their overall debt load. Ask a mortgage lender to explain how this could work for you.
Home improvement projects that add value to your house are another good way to spend the money from a cash-out refi. If you ever decide to sell, the refinance could end up paying itself off in added home value.
Before deciding to undertake a renovation or building project (especially one costing five or six figures), determine whether you will recoup your investment by increasing the likely sale price of your home.
For example, while kitchen and bathroom remodeling will probably increase your home’s value, adding a deck or shrubbery probably will not.
The Student Loan Payoff Refinance
Thanks to a new program offered by the lender SoFi and backed by Fannie Mae, homeowners with student debt now have more incentive to convert those loans into cash-out mortgage refis.
Under the Student Loan Payoff ReFi, homeowners with student loans can take refinance their mortgage and use the extra equity to pay off their student loans.
Not only does this cancel student loans, but the rate homeowners pay on their new mortgage is likely lower than those associated with student loans.
The program makes the most sense for homeowners with private student loans and parents who’ve taken out student loans on behalf of children.
That’s because, according to the Times, the current interest rate for federal undergraduate loans is only 3.76%, whereas the federal rate for parents of undergraduates or graduate students is 6.31 percent.
Meanwhile, the average interest for a fixed-rate private student loan is about 6.5 percent, though some can be much higher.
SoFi and Fannie Mae estimate that 8.5 million households are potentially eligible to pay down or pay off student debt using the new cash-out refinance program.
Not-So-Smart Reasons to Cash Out
As almost any financial advisor will tell you, using home equity to finance short-term expenses – especially vacations or other leisure activities – is usually not a smart move.
But that is exactly what many millennial homeowners are doing, according to a recent Discover Home Equity Loans survey.
(Note: Although the survey polled homeowners who had received home-equity loans, the results may well reflect the behavior of those who have done cash-out refis.)
The Discover report found that 51.3% of homeowners between 30 and 34 (who have owned their property for three years of more) have taken a home-equity loan out against their home.
The most popular reasons for getting the loans were vacations (43.3%), emergency cash (41.8%), home remodels (41.1%), medical expenses (36.2%) and weddings (31.2%).
By contrast, debt consolidation and home remodeling were the top responses from every other age group that was polled.
While they large surge in cash-out refinances might seem unreasonable, there are plenty of reasons it makes sense. Rates today are historically low, and as long as the cash is going to right place, a cash-out refinance can easily save homeowners money.