Mortgages

Why a Cash-In Refinance Might Make Sense

A cash-in refinance is the polar opposite of what we saw consumers doing during the prior decade when they were using their houses like piggy-banks while the mortgage bubble inflated.  At that time, each time a homeowner executed a refinance, they could take cash out of their house (positive equity), and just keep upping their loan amount and paying it down at the new lower rate.  We know how that turned out.  However, more recently, many consumers are taking the opposite approach and actually bringing cash TO the refinance either out of necessity or due to an actual positive return anticipated.  It worked for us and it might work for you as well.  Here are some typical scenarios where this makes sense:

  • Avoid PMI – This is the situation we were confronted with in 2009.  Our house had lost about $20,000 in value since we bought in 2005 according to the appraisal and since we had an interest-only mortgage to start, there was no equity build due to principal payments.  With an enticing 4.625% 30-year conventional mortgage rate, we were confronted with the option of either doing a refinance based on our current loan to value which would require PMI (probably ~$125-$150/month) or just bring extra cash to the closing to bridge the difference and get us back to 80% LTV.  Since we had the cash the the ROI was so generous, we opted to bring cash to the closing rather than pay PMI.  Aside from the fact that I cringe at the prospect to fronting monthly fees to cover other people who default on their mortgages, the actual financial justification was quite strong.  First off, the cash I bought to closing was principal due on the house anyway, so it wasn’t lost money – it would come back upon resale or be that much less we owed on the mortgage.  As far as the PMI, with a conservative assumption of $1500 lost each year on those payments, it was a faily attractive “risk-free” investment.
  • Get Out of Jumbo Loan Territory – For most areas, loans over $417K carry a higher interest rate because they’re considered “jumbo” loans, or higher risk due to the size of the mortgage.  If you’re on the fringe and owe say, $430K and it’s time for a refinance, maybe it makes sense to bring the extra $13K to closing in order to get a lower interest rate.  For a mortgage amount that large, even a quarter point would have a substantial impact on monthly mortgage payments.
  • Moving from a 30-Year to a 15-Year Term – With rates at historic lows, people with perfect credit can get a 4.0% or lower 15 year conventional mortgage these days.  The way amortization works, even though the duration of the loan is cut in half, the mortgage payments aren’t twice as much, but they are certainly higher than a 30 year conventional.  Therefore, some people may want to bring a little extra cash to closing when locking in a 15 year mortgage so those monthly payments aren’t substantially higher than their old payment.

During the first quarter of 2010, Freddie Mac estimated that 18% of all refinancing activity involved a Cash-in Refi, so it’s evident that many Americans are going this route.  Before jumping into this situation, of course, consider what the opportunity cost of that cash is – other investments, emergency fund, etc.  However, in most cases, you’ll probably find that from a return on investment standpoint, it’s a sound move.

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