FAQ about trading equity for cash -- Page 2

I want to pay off a home equity line of credit (HELOC) and pull out additional cash. Which is better: a 10-year line of credit at a variable rate, a 20-year fixed-rate home equity loan or a cash out refinance?
Borrowing money you don't need is expensive. But, if you can invest the additional cash at a higher after-tax rate of return than the after-tax cost of debt, it can be to your advantage to borrow the money and invest it until you need it. To find out the after-tax cost of debt, multiply your loan rate by the quantity one minus your marginal federal tax rate minus your state tax rate. Taking this approach to invest in the stock market isn't for the faint of heart, especially if the value of your stocks heads south. Paying back money that you lost in the market is never fun.

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The best option is to roll the refinancing up into a new first mortgage, preferably a 15-year fixed rate mortgage. You'll have higher closing costs on a first mortgage than you would on a home equity loan, but reducing your interest expense in repaying the old HELOC will make it worthwhile and you'll have financed your cushion at a lower rate as well.

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Once a person gets a mortgage, is there a length of time one must wait before refinancing?
Unless there is a prepayment penalty clause in a mortgage, you can refinance anytime.

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How do I know when it's time to refinance? With the new lower interest rates, is it worth refinancing?
To refinance, you need to lower your monthly payments by enough to cover your closing costs on the loan before you sell the house. A no-cost refinancing is tempting, but it really isn't free. You either pay a higher interest rate than you would otherwise or wind up borrowing the closing costs. Don't just look at the lower payment and commit to the refinancing. Understand how the lender is covering the closing costs. Bankrate's refinancing calculator can help you determine the number of months it will take to recoup your costs.

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We want to consolidate our debts and are considering a mortgage to refinance up to 120 percent of the value of our home. How do these loans work and is it a good idea?
Financing 120 percent of the home's value puts you upside-down in your home, meaning you owe more than the house is worth. That makes it extremely difficult to sell, especially if you have to pay a real estate agent 6 percent of the selling price. If you think landing upside down in a car is trouble, try being upside down in a house. You can't count on rising home prices to dig you out of that hole quickly.

Plus, you lose some of the tax advantage when you refinance a home for more than its value. The proceeds of the refinancing must go to either home improvements or the purchase of a second home to be fully deductible. If the cash is used for something other than that, such as to pay debts, the IRS imposes limitations. The total home equity debt is limited to the smaller of: $100,000 or the fair market value of your home less the amount owed on the original mortgage. Interest on amounts over the home equity debt limit generally is treated as personal interest and is not deductible.

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I'd like to refinance our home and take cash out to pay off loans and credit card bills and end up with additional cash to invest in property. My husband just wants to leave things alone and pay our bills as we go along. Which is the wiser choice?
Mortgage loans on a primary residence are the least expensive form of borrowing for most consumers. That's especially true if you can use the mortgage interest deduction on your state and federal income taxes. Assuming you can use the mortgage interest deduction, the effective rate on the new mortgage should be less than even your auto loan. You can estimate your effective after-tax rate on your mortgage by multiplying the interest rate by one minus your tax rates.

If you go past an 80 percent loan-to-value, the lender will require private mortgage insurance on the loan. That means that you have to limit your list of things to do with the cash from the refinancing. Keeping the home equity component of the loan under $100,000 is also important for the deductibility of interest payments. IRS Publication 936 Home Mortgage Interest Deduction, has more on this aspect of the refinancing.

When you roll an auto loan into a mortgage, you're taking 30 years to pay for the car. That's also true for the credit card debt and the student loans. You can shorten the term of your mortgage by making an additional principal payment each year. It will accelerate the mortgage payoff by about six years.

In taking cash out to invest in property, you're taking on the risk that the appreciation in the property won't outpace your interest expense. There are very few sure things in this world, so make sure you are comfortable with the risks inherent in this approach before loading up on mortgage debt.

Back to top

What are the tax implications of getting cash out when refinancing?
Cashing out of your main home is a great tax strategy if you're using the proceeds to pay off other debt on which the interest is not deductible.

An individual is allowed to take out up to $100,000 from their principal residence in addition to the original debt used to buy the home, and deduct the interest charged before it is repaid. For more information on this, check out IRS Publication 936 Home Mortgage Interest Deduction.

This strategy is a winner since it allows the homeowner to possibly refinance other debt that may be at a higher interest rate than rates available on a second mortgage, allows the homeowner to receive a tax benefit by deducting the interest on the loan which in effect let's the government pick up part of the tab on the loan repayment, and lastly, it allows the homeowner to remain in his current home which he may feel he would have to otherwise sell to cash out. The rules are different on cashing out of a rental property.

Back to top

I want to pay off a home equity line of credit (HELOC) and pull out additional cash. Which is better: a 10-year line of credit at a variable rate, a 20-year fixed-rate home equity loan or a cash out refinance?
Borrowing money you don't need is expensive. But, if you can invest the additional cash at a higher after-tax rate of return than the after-tax cost of debt, it can be to your advantage to borrow the money and invest it until you need it. To find out the after-tax cost of debt, multiply your loan rate by the quantity one minus your marginal federal tax rate minus your state tax rate. Taking this approach to invest in the stock market isn't for the faint of heart, especially if the value of your stocks heads south. Paying back money that you lost in the market is never fun.

The best option is to roll the refinancing up into a new first mortgage, preferably a 15-year fixed rate mortgage. You'll have higher closing costs on a first mortgage than you would on a home equity loan, but reducing your interest expense in repaying the old HELOC will make it worthwhile and you'll have financed your cushion at a lower rate as well.

Back to top

Once a person gets a mortgage, is there a length of time one must wait before refinancing?
Unless there is a prepayment penalty clause in a mortgage, you can refinance anytime.

Back to top

How do I know when it's time to refinance? With the new lower interest rates, is it worth refinancing?
To refinance, you need to lower your monthly payments by enough to cover your closing costs on the loan before you sell the house. A no-cost refinancing is tempting, but it really isn't free. You either pay a higher interest rate than you would otherwise or wind up borrowing the closing costs. Don't just look at the lower payment and commit to the refinancing. Understand how the lender is covering the closing costs. Bankrate's refinancing calculator can help you determine the number of months it will take to recoup your costs.

Back to top

We want to consolidate our debts and are considering a mortgage to refinance up to 120 percent of the value of our home. How do these loans work and is it a good idea?
Financing 120 percent of the home's value puts you upside-down in your home, meaning you owe more than the house is worth. That makes it extremely difficult to sell, especially if you have to pay a real estate agent 6 percent of the selling price. If you think landing upside down in a car is trouble, try being upside down in a house. You can't count on rising home prices to dig you out of that hole quickly.

Plus, you lose some of the tax advantage when you refinance a home for more than its value. The proceeds of the refinancing must go to either home improvements or the purchase of a second home to be fully deductible. If the cash is used for something other than that, such as to pay debts, the IRS imposes limitations. The total home equity debt is limited to the smaller of: $100,000 or the fair market value of your home less the amount owed on the original mortgage. Interest on amounts over the home equity debt limit generally is treated as personal interest and is not deductible.

Back to top

I'd like to refinance our home and take cash out to pay off loans and credit card bills and end up with additional cash to invest in property. My husband just wants to leave things alone and pay our bills as we go along. Which is the wiser choice?
Mortgage loans on a primary residence are the least expensive form of borrowing for most consumers. That's especially true if you can use the mortgage interest deduction on your state and federal income taxes. Assuming you can use the mortgage interest deduction, the effective rate on the new mortgage should be less than even your auto loan. You can estimate your effective after-tax rate on your mortgage by multiplying the interest rate by one minus your tax rates.

If you go past an 80 percent loan-to-value, the lender will require private mortgage insurance on the loan. That means that you have to limit your list of things to do with the cash from the refinancing. Keeping the home equity component of the loan under $100,000 is also important for the deductibility of interest payments. IRS Publication 936 Home Mortgage Interest Deduction, has more on this aspect of the refinancing.

When you roll an auto loan into a mortgage, you're taking 30 years to pay for the car. That's also true for the credit card debt and the student loans. You can shorten the term of your mortgage by making an additional principal payment each year. It will accelerate the mortgage payoff by about six years.

In taking cash out to invest in property, you're taking on the risk that the appreciation in the property won't outpace your interest expense. There are very few sure things in this world, so make sure you are comfortable with the risks inherent in this approach before loading up on mortgage debt.

Back to top

What are the tax implications of getting cash out when refinancing?
Cashing out of your main home is a great tax strategy if you're using the proceeds to pay off other debt on which the interest is not deductible.

An individual is allowed to take out up to $100,000 from their principal residence in addition to the original debt used to buy the home, and deduct the interest charged before it is repaid. For more information on this, check out IRS Publication 936 Home Mortgage Interest Deduction.

This strategy is a winner since it allows the homeowner to possibly refinance other debt that may be at a higher interest rate than rates available on a second mortgage, allows the homeowner to receive a tax benefit by deducting the interest on the loan which in effect let's the government pick up part of the tab on the loan repayment, and lastly, it allows the homeowner to remain in his current home which he may feel he would have to otherwise sell to cash out. The rules are different on cashing out of a rental property.

Back to top