Resist The Temptation To Do A Cash-Out Refinance As Rates Collapse

With record-high home equity and declining mortgage rates, the temptation to do a cash-out refinance is growing. I’ve certainly considered it myself. However, after careful reflection, my conclusion is that it's probably not the best move.

Having written about refinancing since 2009, I’ve seen too many unfortunate cases where people took out a Home Equity Line of Credit (HELOC) or did a cash-out refinance, only to harm their overall financial health. The urge to spend on unnecessary things was simply too hard to resist.

The less debt you carry, the better. Ideally, you want to finish your working years debt-free, so you can enjoy a financially stress-free retirement.

A cash-out refinance increases your debt load and heightens the risk of falling behind on your financial goals. As we get older, time becomes our most precious resource, and moving backward financially only costs us more of it.

My Master Plan to Buy Real Estate and Then Do a Cash-Out Refinance

In 2023, I devised a two-step plan to improve both my finances and lifestyle.

The first step was to pay cash for a home, as high mortgage rates had dampened demand. By purchasing with cash during that period, I aimed to secure a better deal and avoid high mortgage costs. The second step was to patiently wait for mortgage rates to decline, then do a cash-out refinance to re-liquify my assets.

I successfully executed step one and bought my forever home at a discount in October 2023. Since then, home prices have risen by 10%–15%, as seen in the 2024 spring bidding wars. Meanwhile, mortgage rates have dropped significantly, falling nearly 2% from their peak.

Now, I’m faced with a decision: should I take advantage of these lower rates by cashing out? I suspect some of you may have had the same master plan and are now wondering the same thing.

For long-time homeowners, with so much home equity built up, why not unlock some of it to enhance your life now? Never mind that you’re already enjoying your home that has risen in value—you want more!

Why You Probably Shouldn’t Do a Cash-Out Refinance

I have 80% confidence that bidding wars will be even more intense in the first half of 2025 than they were in 2024. Such bidding wars will push median home prices to new all-time highs. We’re heading into the ideal environment for real estate price appreciation due to the following factors:

• Pent-up demand
• Undersupply of homes
• Declining mortgage rates
• A soft economic landing or mild recession
• Record-high stock market wealth
• A multi-year Fed rate cut cycle
• Clarity on the next presidential administration and potential housing incentives
• A potential rotation of capital from public equities to real estate

Even if you’re highly confident that real estate prices will continue to rise, there’s always a chance they won’t. There’s always a possibility you could lose your job, face a health crisis, or lose your home to a natural disaster.

Are you comfortable taking on more debt when there’s a one-in-five chance of loss? If you are over the age of 40 and have a family to take care of, the answer is no. Don't do a cash-out refinance.

Resist the temptation to tap into your home equity by reminding yourself that you’re already doing an excellent job providing for your family. Don’t jeopardize that progress. You've worked hard to build up substantial equity for your retirement, whether you have children or not—don’t risk it now.

You’re Already Winning With All That Home Equity

As someone striving for financial independence, your goal should be to eliminate debt by the time you no longer want, or are able, to work. If you’ve paid cash for your primary residence or paid it off, you’ve achieved one of the most critical milestones for financial independence.

If you have more than 50% equity in your home, you’ve passed the tipping point. Instead of reversing the debt snowball, as more of your mortgage payment goes toward principal, let the snowball accelerate.

Once you have momentum in paying down debt, keep it going. If you do a cash-out refinance, you’re arresting your financial progress. Not only does refinancing cost money, but you’ll also have to pay ongoing interest to service the new debt.

When you’ve paid cash for a home or have a comfortable mortgage amount left, there are few expenses you can’t cover with cash flow. Think about it—beyond food, clothing, shelter, and healthcare, what more do you need? If you have health insurance, you shouldn’t need to do a cash-out refinance for any of these basics.

Keep your wants in check. But what about doing a cash-out refinance to cover more significant needs, like emergencies, college tuition, or more real estate? Let’s discuss.

A Cash-Out Refinance for Emergencies

Emergencies should be covered by cash flow and your emergency fund, which should consist of at least 6 months of living expenses in a liquid account.

It usually takes 1–2 months to complete a cash-out refinance. If you’re facing a true emergency, a refinance won’t provide the funds in time. Instead, a cash-out refinance will first cost you more money given there's a fee to do so. Start building a larger emergency fund now if yours is thin.

A Cash-Out Refinance for College

You’ve had 18 years to save for college, perhaps more if you planned well. There’s no good reason to put your home at risk to pay for college. Tuition should be covered by diligent saving, preferably in a tax-advantaged 529 plan.

Even if you needed $100,000 for college, the cost and time required for a cash-out refinance wouldn’t make it worthwhile. It’s better to cover a shortfall with cash flow, by having your child work, or by using student loans.

Don’t risk your home to pay for unrelated expenses. Compartmentalize your funds and protect your home at all costs. Once you decide to mix up your funds, your chances of getting into financial trouble increases.

A Cash-Out Refinance to Buy More Property

Using home equity to buy more property was common during the low-interest-rate environment. While rates have been declining since 2023, they are still higher than in 2020–2021.

Taking on more debt to purchase another property with debt compounds your risk. The temptation to do cash-out refinances often peaks when real estate mania is at its height. If you get caught in a downturn with too much debt, your net worth could get wiped out.

It’s better to methodically save for a down payment with your cash flow. Over 5–10 years, you can accumulate a 20%+ down payment for another property. Meanwhile, you’re still benefiting from real estate appreciation through your primary residence.

Most homeowners who were obliterated during the global financial crisis had taken on too much debt. As a result, their credit was ruined, preventing them from participating in the subsequent 10-plus-year real estate bull market. That’s a double blow!

What About A Cash-Out Refinance To Buy Stocks?

Doing a cash-out refinance to buy stocks can be even riskier than using the proceeds to invest in real estate. While stocks have historically provided higher long-term returns, they are much more volatile than real estate.

The primary motivation for cashing out to buy stocks is the potential for higher profits, but that's greed talking. Stocks provide no utility, unlike real estate. For this reason, I don’t recommend using a cash-out refinance to buy the S&P 500 or any other stocks. Keep your greed in check, and don't mix funds.

You're already winning with real estate. Keep that success separate from your stock investments.

Doing A Cash-Out Refinance To Pay For Retirement

It's unwise to use home equity for retirement spending. That’s what Social Security, tax-advantaged retirement accounts, taxable investments, and pensions are for. After a lifetime of earning and investing, it’s time to rely on your investments for their intended purpose.

It’s easy to spend home equity on wants rather than needs in retirement.

For example, a 76-year-old woman I know took out $200,000 from her $400,000 home 15 years ago to cover everyday living expenses. Unfortunately, these expenses ballooned due to reckless spending on pets she couldn't easily take care of. Fifteen years later, she still owes about $200,000 on her home. It should have been paid off when she was 62.

Worse, she also owes over $100,000 in revolving credit card debt, encouraged by the money she received from her home equity. Having access to a lot of money can sometimes encourage you to spend even more money. This is why having a broke mindset can be beneficial.

Her financial situation has put immense stress on her children, who are now trying to pay off and close her credit card accounts one by one. As you age, it can become more difficult to keep track of finances, especially as cognitive decline sets in.

Meanwhile, debt is relentless in its compounding of interest. Without a steady paycheck in retirement or tremendous discipline, debt can undo the wealth you spent a lifetime building.

Trapped Equity Can Actually Provide Peace of Mind

Critics of “trapped equity” argue that home equity is unproductive. They say it could be used to earn a higher return. While this is certainly possible, it’s also possible to lose money and end up with more debt and stress.

If you're truly satisfied with what you have, don't further complicate your finances.

People who advocate for extracting home equity are often in real estate or lending, or they’re dissatisfied with their wealth. If you’re still building toward financial independence, reinvesting home equity in higher-returning assets may make sense. But once you’ve reached a point of contentment, the idea of a cash-out refinance becomes less appealing.

There will always be another great property to buy. At some point, you have to be okay with having enough.

Reward Yourself In a Different Way

I get it—what’s the point of saving diligently and taking the risk to buy a property if you can’t maximize the rewards? There are even people in the personal finance world who still defend their decision to sell their homes in 2012 or rent for over a decade. Compared to them, you’re crushing it!

You absolutely deserve to enjoy the progress you've made in building your wealth. And you already are—by living in your home. Not only are you providing for your family and creating wonderful memories, but you also have the option of tapping into your home equity if you really need it.

However, if you do cash out, you’ll have to figure out what to do with the proceeds, which can bring added stress about reinvesting. Instead, reward yourself with peace of mind and a hot fudge sundae instead.

Sure, your home's value could rise even more if mortgage rates decline, creating even more equity to tap. But don’t give in to temptation. The fact that you're continuing to build home equity should be rewarding enough.

Now, if mortgage rates drop below 3% again, you might consider doing a cash-out refinance and making it rain. In the meantime, keep things simple and stay focused on your journey toward financial independence.

To Summarize Why You Shouldn't Do A Cash-Out Refinance

Here are the top reasons for not doing a cash-out refinance:

1. Higher Interest Rates: If current mortgage rates are higher than your existing rate, a cash-out refinance will increase your monthly payments and cost you more in interest over time.
2. Closing Costs: Cash-out refinances involve significant closing costs, typically 1%-4% of the loan amount. These costs can erode the financial benefit of pulling equity from your home, especially if you’re not planning to stay long-term.
3. Risk of Foreclosure: Since the loan is secured by your home, if you're unable to make payments, you risk foreclosure. This makes tapping into home equity risky if your income or financial stability is uncertain.
4. Resetting the Loan Term: A cash-out refinance typically extends your mortgage term, even if you’ve already paid down a significant portion of the original loan. This could mean paying more in interest over the life of the loan, even if the monthly payment is lower.
5. Depleting Home Equity: By taking out a portion of your home’s equity, you reduce your ownership stake in the property, leaving you with less equity in the event of a housing market downturn or if you need to sell.
6. Potential to Overborrow: With a cash-out refinance, you might be tempted to borrow more than necessary, putting your financial future at risk if the funds are not used wisely.
7. Tax Implications: The interest on a cash-out refinance is only tax-deductible if the funds are used for home improvements. Using the money for other purposes—like paying off debt or funding vacations—won’t qualify for tax deductions, reducing the potential benefit.
8. Negative Impact on Credit: A larger loan balance increases your debt load, potentially affecting your credit score and making it harder to qualify for future loans or credit lines.
9. You've Almost Won The Game: If you own your home free and clear, you've achieved a significant financial independence milestone. Your goal should be to keep moving forward, not backward on your road to financial independence.
10. Stressful To Reinvest The Proceeds: Finally, taking on debt to invest is a risky proposition. Unless you have strong conviction in something specific you want to invest in that will far exceed the interest you will pay, don't do it.

Reader Questions And Suggestion

Have you ever done a cash-out refinance? If so, how much did it cost, how long did it take, and what did you do with the money? Know anybody who cashed out and lost?

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