Cash-Out refinances are refinances where a Consumer obtains a new loan that is larger than the loan they are paying off and the difference between the higher loan and the loan being paid off is received by the Consumer in cash after costs are paid. Consumers apply for Cash-Out refinances to:
Obtain cash for home improvements, to pay college tuition for their children, to take vacations or buy a new car or recreational vehicle.
To convert non-tax-deductible, higher interest consumer debt amortized over a shorter period of time into tax deductible mortgage debt which is generally financed at a lower interest rate and amortized over a longer period.
The benefits to Cash-Out Refinances can be huge. While the benefits are many, here are a few to consider:
Cash-Flow. Consumer debt like credit cards are financed with a payment between $300-$350 per $10,000.00 borrowed whereas $10,000 of mortgage debt carries a payment between $50-$55 dollars. A Consumer struggling to meet the payments on $20,000.00 in Consumer debt and a $15,000 balance on a vehicle could see as much as $1,000 of savings in their monthly budget. One thing to consider when consolidating debt is that it often extends the repayment terms and if the savings are not applied to the principal a Consumer could extend their debt repayment term.
Generally, we recommend that a Consumer, if they can afford to, applies the monthly savings back to the principal of the debt. This will reduce the debt faster than a Consumer would have at the higher interest rate. Consumers who apply this approach could see financial independence come sooner than they thought possible.
Reduce Finance Costs. Consumer debt is usually offered at higher interest rates than mortgage debt. Because mortgage debt is secured by an appreciating asset the financing terms are usually much better. Consumer debt, like credit cards, can carry interest rates from 10% to even 20% or higher and short-term consumer loans can carry interest rates higher than 100%. Mortgage debt however is generally financed at less than 5% so converting consumer debt into mortgage debt generally reduces the overall financing costs.
Tax Savings. Interest and other financing costs on consumer debt is generally not tax-deductible while mortgage interest is often times fully tax deductible. If a consumer has a 25% federal income tax rate (for taxable income above $37,950 and less than $91,000) and a state income tax of 9.3% (for taxable income above $51,531 and less than $263,222) then that means that a Consumer or family earning $52,000 per year who converts non-tax-deductible Consumer debt into tax-deductible mortgage debt will save more than 34% of the interest expense on that debt in tax deductions. We recommend that our clients seek advice from their tax professionals prior to refinancing.