A cash-out refinance can cost you big

Photo: Ben Husmann

Cash-out refinancing has a somewhat deservedly bad reputation because during the housing bubble years, people used their homes as ATMs or piggybanks. Cash-out refinancing contributed to the number of homeowners who ended up underwater and played a role in the housing crisis.

The popularity of cash-out refinancing may have declined, but many borrowers are still doing it.

A cash-out refinance -- assuming you have the equity -- might seem like a good short-term solution when you don't have enough money to pay for a major expense.

It's easy, interest rates are low and mortgage interest is tax-deductible.

But even if you don't end up underwater or otherwise get in trouble by cashing out, you could still be hurting your finances in the long run.

Cashing out often works out to be very expensive because of how mortgage amortization works. At the beginning of your loan, most of your monthly payment goes toward interest. It’s not until the later years of your loan that most of your monthly payment goes toward principal.

Before doing a cash out refinance, you need to calculate the long-term costs of doing so in order to make an informed decision. To uncover the total costs, use an online amortization calculator.

Think about whether what you're cashing out for is worth the true cost and the impact on your net worth.

Waiting isn't fun, but consider delaying gratification. Instead of cashing out now, why not do a regular refinance to a lower interest rate and use the monthly savings to pay off the mortgage early? Without a mortgage, most people will experience a huge increase in monthly cash flow.

That money can be used for anything, interest-free.

Owning a home free and clear can also bring a significant feeling of accomplishment and might allow for freedoms like quitting your day job to start your own business or working part-time and traveling more.

Avoiding a cash-out refinance now could mean reaching a place of significantly greater financial and personal freedom sooner rather than later.

Learn more about the math behind cash-out refinancing decisions in my Interest.com article, A cash-out refinance can cost you big.

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