Dear Dr. Don,
I'm turning 50 this year and currently am 18 months into a 15-year fixed-rate mortgage. Although I have an attractive interest rate of 3.625%, in today's environment I can refinance, take about $25,000 cash out and maintain the same payment. I could use the cash toward catching up on my 401(k), individual retirement accounts, then other expenses and investment as required. This seems to be a cheap way to do this, so the cash-out refinance seems a no-brainer that would add only about 18 months to my original mortgage. Thoughts? Thanks.
-- Mark Mortgage
Dear Mark,
As I write this, Bankrate's national average for a 15-year fixed-rate loan is 3.48%. For you to have the same payment on a new cash-out refinance and new 15-year fixed-rate mortgage, the interest rate would have to be around 2.625%, or a full percentage point lower than your existing loan.
If you can justify the refinancing on its own, then the cash-out decision comes down to whether you can expect to earn more after-tax on your investments than you pay after-tax on your mortgage. You're borrowing to invest. That makes sense only when you earn more on your investments than you pay on your loan.
I did a little back-of-the-envelope calculating. It may not exactly represent your situation, but it should be close. I assumed you could get the new mortgage at 3%.
| Existing mortgage | Cash-out new mortgage | Difference | New mortgage without cash-out | Difference from existing mortgage | Just the cash-out money | |
| Loan balance | $ 153,552 | $ 178,552 | $ 25,000 | $ 153,552 | $ 25,000 | |
| Interest rate | 3.625% | 3% | 3% | 3% | ||
| Loan term (in months) | 162 | 180 | 180 | 180 | 180 | |
| Loan payment | $ 1,200.02 | $ 1,233.05 | $ 33.03 | $ 1,060.40 | -$ 139.62 | $ 172.65 |
| Total interest expense | $ 40,852 | $ 43,397 | $ 2,545 | $ 37,320 | -$ 3,532 | $ 6,077 |
The cash-out refinance has you paying an additional $2,545 in total interest expense. You realize $3,531 in savings from refinancing the existing mortgage but effectively pay an additional $6,076 in interest expense to borrow the $25,000 and repay it over 15 years. Together, those numbers give you the net increase in interest expense of $2,545. I've ignored the tax impact and any closing costs.
The refinancing decision on its own is a nip-and-tuck, depending on the loan's closing costs and how long you plan to be in the mortgage. You have to decide if your after-tax investment yields are expected to be higher than the after-tax rate on your mortgage before you commit to the cash-out part of the new mortgage.
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