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| Saturday, February 06, 2010 |
| Cash-in refinancing - a growing trend |
The Washington Post article: Cash-in refinancing could help homeowners save reports that more people are taking money out of savings and using it to lower their mortgage principal balance when refinancing their loan. A bit shocking after so many years of Cash-out financing being so popular. "It almost sounds un-American," jokes Frank Nothaft, chief economist for mortgage giant Freddie Mac. After all, Americans have grown accustomed over much of the past two decades to tapping into their equity -- pulling out a chunk of cash and adding to their debt load -- when they refinanced their mortgages. "Almost nobody thought of putting money back in," he says.
Cash-outs hit their highest level of popularity during the wild appreciation streaks in the early and middle years of the past decade. In mid-2006, just before home values began deflating across the country, the rate of cash-outs hit 88 percent, according to Freddie Mac, which monitors refinancings quarterly.
This meant that nearly nine out of 10 refinancers whose loan files were sampled by Freddie Mac increased the size of their mortgage balance by at least 5 percent. It was the heyday of the pile-on-more-debt mind-set -- cash me out, I can't lose on my real estate -- that came crumbling down in 2007 and 2008, when home equity holdings shrank drastically and painfully.
From 2005 to the third quarter of 2009, according to Federal Reserve estimates, American homeowners lost $7 trillion in equity -- an unprecedented evaporation of household wealth. Almost nobody was spared.
Now the pendulum in consumer psychology appears to be swinging toward reduction of household debt -- whether credit cards or mortgages. In Freddie Mac's latest quarterly survey of refinancings, 33 percent of homeowners put cash into the deal to lower their mortgage balances, the highest percentage ever. By contrast, only 27 percent of refinancers took cash out -- the lowest percentage on record. The article goes on to point out that with interest rates so low, taking money out of savings and paying down your mortgage may be the best return available at the moment. While I have not refinanced, I am pouring as much money as I can toward reducing my mortgage principal. Good to know that I am not alone in "cashing-in" on my mortgage. |
| posted by Boston Gal @ 2:37 PM *
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| 13 Comments: |
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My wife and I have paid down our principal by quite a lot in the last few years. We could actually pay it all off right now, but that would cut into our emergency fund. In this economy we prefer hanging onto enough cash to get through a full year of unemployment without running up debt in case one or both of us gets laid off.
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I think MattH is wise not to reduce his emergency fund to pay down his mortgage. In our home, we have been weathering a long bout of unemployment, and we are very glad to have our cushion of emergency money. When unemployed, the important thing becomes getting by month to month, as opposed to increasing wealth. Increasing wealth can come again in the future.
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Im so torn these days about reducing our mortgage balance with acelerated payments. Our mortgage is so cheap at <5% in 5-10 years I think that very well might sound like extremely cheap money compared to future interest rates. On the flip side it would be a great feeling to reduce our debt.
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On the other hand, if what comes later in 2010 is big inflation, you'll have paid off a relatively cheap loan with dollars that can no longer work for you...
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I agree that having a very healthy emergency fund is critical and why I am using monthly excess cash to pay down my principal - after taking years to build up my cash accounts, I was not about to drain them for this purpose.
But since I am still employed, have a robust emergency fund, qualify for decent unemployment (if the worst should happen) and have alternate income to rely on with my rentals - pairing down the debt level makes sense to me at this point in time.
All that said, I am still maxing out my 401(k) contributions and Roth IRA - so future saving/investing does continue.
Inflation is a worry, but that is an unknown, while my mortgage balance is a known.
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Another advantage to MattH's approach is that if the principal balance on the mortgage is at around a year's expenses, the interest is almost certainly a small percentage of the monthly payment. If I'm correct on that (it'll likely be true if the loan started out significantly bigger, but not of MattH and his wife started with a small loan), the interest is effectively serving as cheap unemployment insurance by leaving the emergency fund intact.
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A cash-in refi packs a great 1-2 punch to the 'ole mortgage. I did this last year, reducing my principal by one-fifth and my monthly payments by one-third. It felt great. And the plan is to route the monthly savings right back into reducing the principal.
I had a good emergency fund in place first. In fact, most lenders today would probably not let you run down your reserves below a certain level to do a cash-in refi even if you wanted to.
There will always be two schools of thought about paying off your mortgage early. For me, paying it off gives a much better yield than any deposit account at present. And I agree with Boston Gal that inflation may be years away or not happen at all. If we do see inflation, perhaps I'll revert to the regular payoff schedule. In the meantime, I'm making the best use of my money.
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Why not invest the money instead of paying down the loan?
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"Why not invest the money instead of paying down the loan?"
If you know of a currently available investment with a guaranteed return exceeding 4.625% (my mortgage rate), I'd love to hear about it. Without question, deposit rates will go up in the future. But when that will happen is anybody's guess. By parking your money in some savings or money market account earning 2% (if you are lucky) and waiting for that to happen, you are actually losing ground.
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Even at 4.625% your after tax effective rate is really only about 3.75%. If you can't beat that in the long then something might be wrong.
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Speaking for myself, I am still investing dollars every month. I contribute the maximum allowable in my 401(k) and Roth IRA. But this year I am also focused on paying down my mortgage principal.
I could instead invest my excess monthly dollars in a taxable account - but then I would need to secure gains (after taxes) that would beat the long term savings I am currently enjoying by paying down the principal on my mortgage.
But more importantly, paying off the mortgage early seems like the safer way to give myself a more secure nearer term future.
Who knows what the next decade will bring. If the market starts gaining in leaps and bounds again - great. I will benefit from my retirement contributions. Sure, I would benefit more if I put more cash into the market - but I am not greedy. Even better would be for the market to go up, I benefit, and I am 100% debt free.
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Like Boston Gal, I continue to put money into other accounts while I pay down my mortgage. It is not an "either-or" situation. So whatever the economy does, I stay flexible and things will be fine. For me also, the security of owning the roof over my head free and clear is preferable to chasing some hypothetical long-term return. Other people will have different priorities, risk tolerances, and viewpoints. The best course of action is ... whatever is right for your own circumstances.
So where is that list of great investments with a guaranteed better after-tax return than current mortgage rates?
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interesting article.