Cash Back Refinancing Caution

For homeowners that are struggling to keep up with their mortgage payment, refinancing has provided some much needed financial relief. Applying for a new loan with a lower interest rate through a refinancing option can lower the interest rate on the loan. A lower interest rate reduces the overall monthly mortgage payment, freeing up some funds to be used for other expenses. A commonly utilized option with refinancing has been to borrow more than was owed on the home and “cash out” the difference. Homeowners could then use this cash back amount to pay off other debts or use for additional expenses. Although refinancing a mortgage loan can help save the home when foreclosure is looming, it does come with some risks and costs.

Risky Business

Not all refinanced loans are equal, and certainly not all produce the desired effect. Whether the mortgage payment is reduced through refinancing depends on when the loan was refinanced and what type of loan the original mortgage loan.  Since rates are still relatively low in today’s market, refinancing may provide some relief from higher interest loans; however, if the loan was refinanced when rates were still high, the reduction in monthly payments may have been less than adequate. Refinancing is unlikely to produce any significant reduction in the monthly payment for homeowners under an adjustable rate mortgage (ARM) loan. ARM loans are based on the prime interest rate set by an industry standard rate, plus a small percentage the bank makes off the loan. Refinancing may lower the percentage the bank takes off the loan, but the prime rate cannot be lowered through refinancing and as it adjusts upwards, so will the monthly payments.

Cash Is Not King

Although the cash out option may entice many into refinancing, homeowners should consider the long term effects of refinancing more than is needed to purchase the home. When refinancing a home, there are additional closing costs required for the new loan. A homeowner that cannot afford to pay these costs should consider other options for lowering their monthly payments, such as forbearance.

It is easy for people to use the cash back money for paying other debts, funding large purchases such as a car, paying for tuition or education expenses or taking a vacation. The problem is that this is money that must be repaid. Once the refinanced loan is approved, the liability on the debt extends to the total amount of the loan. In many cases, a homeowner ends up with a really expensive personal loan that will cost thousands more in interest fees over numerous years to repay. Anyone considering a cash back refinanced loan should be sure that spending those funds won’t result in more debt.