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Should I Do a Cash-Out Refinance to Invest?

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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%.

Mortgage options
  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
Note: Numbers may vary slightly due to rounding.

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.

Bank Rates

Loan Type Graph Rate +/- Last Week
30 Y Fixed Graph 3.83% dw 3.86%  
15 Y Fixed Graph 2.95% up 2.94%  
30 Y Fixed Jumbo Graph 4.27% up 4.24%  
5/1 ARM Graph 3.13% up 3.05%  
5/1 Jumbo ARM Graph 3.77% up 3.70%  
Loan Type Graph Rate +/- Last Week
$30K HELOC Graph 4.40% up 4.38%  
$50K HELOC Graph 4.07% up 4.06%  
$30K Loan Graph 4.54% dw 4.56%  
$50K Loan Graph 4.20% -- 4.20%  
$75K Loan Graph 4.20% -- 4.20%  
Loan Type Graph Rate +/- Last Week
36 M New Graph 3.07% dw 3.08%  
36 M Used Graph 3.29% dw 3.30%  
48 M New Graph 3.05% dw 3.06%  
48 M Used Graph 2.96% up 2.87%  
60 M New Graph 3.13% dw 3.14%  
Loan Type Graph Yield +/- Last Week
6 month Graph 0.37% up 0.36%  
1 yr Graph 0.61% -- 0.61%  
5 yr Graph 1.44% dw 1.48%