Thinking About Refinancing Your Mortgage? Think Again

Recently, more and more homeowners have begun taking advantage of the various mortgage refinancing options available to consumers.  The third quarter of 2006 saw the highest number of "cash-out" mortgage refinances of any quarter since 1990.  [1]  While cash-out refinancing can put money in the homeowner's pocket for things such as home repairs or remodeling, or simply free up money to consolidate and pay off other debts, higher interest rates on a higher amount of money financed as a mortgage may not make good financial sense.  Homeowners should also be wary of the recently highly publicized "interest-only" refinancing option which lowers payments in the short-term but increases them dramatically after only a short period of time. [2]   

Cash-out refinancing is a mortgage refinancing option that allows a homeowner to collect a check at the closing for the amount of cash taken out of the equity built in the home,with the mortgage then refinanced at the higher amount under the new terms of the mortgage. [3]  For example, if a person's home is worth $200,000 and he has paid back $100,000 of his first mortgage, he has gained $100,000 in equity.  If that person then chooses to do a cash-out refinance, he can take out as much of that $100,000 of equity he wants to receive in cash (and that the lender will approve) and add it on to the mortgage.  So, if the person cashes out $50,000, he will receive a check for $50,000 at the closing and his new mortgage will be for $150,000 financed under the terms of the new mortgage.  This differs from a home equity loan in that under a home equity loan, a person keeps his original mortgage and takes out a second mortgage under new terms for the amount of money he takes out of the home. [4] 

In recent months, cash-out refinancings have resulted in refinanced mortgages that were an average of 5 percent higher than the first mortgages on those homes. [5]  While having cash on hand may sound like a good deal, cash-out refinancing can be a bad deal for the unwary refinancer, especially with recent rises in interest rates.  Homeowners should shop around for cash-out options in order to ensure they are getting the best possible interest rate on the new mortgage, and to ensure that the new rate is a lower one than the first mortgage.  In addition, homeowners who are already locked into good mortgage terms at a low interest rate should consider taking out a home equity loan so they are only taking out small amount of money at the new presumably higher interest rate, rather than refinancing their entire home mortgage at a higher rate.

Another refinancing option presents more potential problems for the unsavvy refinancer, wooed by commercial on television encouraging people to take advantage of lowering their monthly mortgage payment.  This is the "interest-only" option.  Interest-only refinancing takes a homeowner's mortgage and refinances it into a new mortgage that is structured in tiers so that the homeowner only initially pays the interest for a period of time, then begins to pay off some of the principle with interest, and then (in some types of interest-only loans) later pays off more of the principle with interest each month. [6]  While this may sound appealing, the terms of these loans may come as a surprise to people who have been faithfully paying their mortgage for a few years, then suddenly they realize that their monthly payment has doubled or even tripled.  These loans can be deceptive since they often guarantee that "your principle balance will NEVER increase." [7]  While this may be the case, this does not meant that one's payment will never increase, only that the principle amount, i.e. the amount financed, will not increase due to the way the interest and principle payments are structured. 

An example of this type of mortgage that is commonly offered on television commercials works like this:  A person buys a home for $150,000.  For the first 10 years, the interest only payment is $953. [8]  After 10 years, the principle and interest payment becomes $1219. [9]  In addition, the rates on these mortgages are not fixed and could fluctuate to make payments even higher. [10] What people fail to realize in this instance is that they are only paying interest on the loan for the first 10 years and are building no equity in their home!  This might be a good deal if you are 75 years old with no family, but for most homebuyers, this is not a good option.  Other examples offered in the fine print of commercials advertising these mortgages are even more drastic with mortgage payments increasing from $700 to $1200 to $1500 over a period of years.  Overall, interest-only mortgages do not make good financial sense, as one is better off spending that money on rent and not tying up all of one's credit.   

People considering refinancing their mortgages should be careful to investigate all available options and only agree to new terms after carefully examining the fine print.  Otherwise, the unwary refinancer is only likely to quicken their debt. 


[1] Sue McAllister, Higher Rates Spur 'Cash-out' Refinancings, San Jose Mercury News, Nov. 1, 2005.

[2], Interest Only is All About Choices,

[3] See, Cash-out Refinance vs. Home Equiy Loan,

[4] Id.

[5] Cash-out Refinancing Hits Peak, CNN Money,

[6] See Interest Only is All About Choices, supra note 2.

[7] Id.

[8], Smart Choice

[9] Id.

[10] Id.