eli5: What is cash-out refinancing and why did so many homeowners choose to do this during 2020-2021? Also, are there any hidden dangers in this type of refi that are less talked about?
In: 0
Let me use a hypothetical example. I’m going to presume this person has been just fine through the last two economic crises.
In 2012, you buy a home for $170,000 (US median price) using an FHA %3.5 down payment loan. You pay about $920 per month plus taxes and insurance. In 2021, you’ve paid down your loan to about $135,000, but your property value has increased to $350,000.
A bank is more than happy to loan you $280,000 at a great rate – you need somewhere to live and you have a lot to lose ($70,000 in equity) if you default. So you pay off the old loan and keep $145,000 for yourself. Because of the low interest rates, your new monthly payment only increases to about $1260.
There are three drawbacks that I see:
1. You have a higher payment
2. Your new loan ends in 2052, ten years later than your old, cheaper loan.
3. You should spend the money wisely, you’re going to pay for it for a long time. Do you have the discipline?
For some people, the drawbacks are very worth the extra cash. Install an $80,000 solar system and get rid of your electric bill. Pay off high interest credit cards or student loans. Make some repairs and upgrades on your home.
Other people squander the money.
Still others choose not do it at all.
Latest Answers