Bootstrap Capital LLC
  • Home
  • About
  • Your Advisor
  • What We Do
  • Blog
  • Contact Us
  • Home
  • About
  • Your Advisor
  • What We Do
  • Blog
  • Contact Us

Here We Go Again: Cash Out Refinance

6/23/2017

 
Picture
Recently I read an article in the Wall Street Journal titled: “Homeowners Are Again Pocketing Cash as They Refinance Properties” (subscription required). My first thought: Here we go again.
 
Unfortunately, the article was mostly positive on the development, as the writer’s take was that this reflects confidence in the economy and relative job security. I have no idea if this bodes well for the economy or not (although my intuition says it’s a negative), but on an individual level I think this is a really bad idea. There are no absolutes in personal finance, and everyone’s situation is different. With that caveat out of the way, lets look at why taking cash out of your home when you refinance can be a poor financial decision.
Your home is a good store of value:
Since a portion of your house payment goes towards paying down your mortgage, you automatically increase your home equity over time. When you add in home price appreciation, this represents a good store of value. To be clear, a home that you live in is not an investment. You cannot expect to earn a positive return over a reasonable timeframe by paying off your house, but it can be an excellent store of value. Since most people pay their mortgages on time, you are guaranteed to have a portion of each payment available as home equity in the future - as opposed to renters where their payment does not build any equity.
 
For the average American, this is very important. According to US Census information, home equity represents the bulk of most households’ net worth. It varies by age and income, but for older Americans on average, home equity represents upwards of 80% of their net worth. Needless to say, if you raid this piggy bank now, it won’t be there when you are older and may potentially need it for retirement or some other urgent personal need.
 
Home improvements are a good use of money:
The math on this is pretty straightforward. According to Remodeling Magazine, two popular home renovations, bathroom remodels and kitchen remodels, recoup 65% of their costs. This means that if you spend $100,000 on your remodel, you will increase the value of your home by $65,000. If your home price appreciates by 3% per year, to fully recoup your cost would take 14.5 years. This certainly is not the worst use of home equity funds, but it will certainly leave you less well off financially than when you started.
 
Pay off high interest credit card debt and save some cash:
​
This is one of the worst ideas. And it was specifically mentioned in the WSJ article, which is disappointing. At first glance, this may sound like a great option, but it can be fraught with risk. At the most basic level, credit card debt is unsecured debt. This means that you have received this credit on your good word that you will pay it back. It is not secured against any assets that you own. If you neglect to pay, you will wreck your credit score (thus being ineligible for any more unsecured credit), and you will get lots of phone calls from your credit card company (and later collection agents), but the lender has no recourse to force you to pay. A mortgage is a secured debt - it is backed by your house. If you neglect to pay your mortgage, the bank can and will foreclose on your house. Trading unsecured debt for secured debt backed by your home reduces your financial flexibility and leaves you in a more precarious situation. There are certainly instances where financially disciplined people have gotten into significant debt due to layoff, medical issues, or some other life event that has thrown them for a loop. A person in that situation who gets themselves back on solid financial footing may be able to use home equity as viable tool to help pay off debt – but only if they never run up their credit card balance again. The data indicates that most people will simply run up their credit card balances once they are paid off. Solving the underlying spending and saving issue is the only thing that will permanently eliminate your credit card debt.
 
The financial recovery has finally gotten to the point that homeowners have accumulated significant equity in their homes again. This is certainly a great situation to be in. But, given the heartbreaking situation where many people lost their homes during the last crisis, it would be a shame to think that we have not learned any lessons about using our homes as ATMs. Let’s hope that this article isn’t the canary in the coal mine.

For more information on these topics:
Fun with Mortgage Math
​
Debt Is Bad … but These Debts Are Terrible​

Comments are closed.

    Disclaimer

    Note: The contents of this site are general in nature and not intended as specific investment advice. All investments are subject to risk; including loss of investment value. If you have any question regarding investments or concepts in these pages, please consult with an investment professional.

    Archives

    June 2020
    February 2020
    October 2019
    June 2019
    February 2019
    January 2019
    October 2018
    September 2018
    April 2018
    December 2017
    October 2017
    August 2017
    June 2017
    April 2017
    December 2016
    November 2016
    October 2016
    September 2016
    May 2016
    April 2016
    February 2016
    December 2015
    October 2015
    September 2015
    August 2015
    July 2015
    June 2015
    May 2015
    April 2015
    March 2015
    February 2015
    January 2015
    December 2014
    November 2014
    October 2014
    July 2014
    April 2014
    January 2014
    October 2013
    July 2013
    April 2013
    January 2013
    October 2012
    July 2012
    April 2012
    January 2012
    October 2011
    August 2011
    July 2011
    April 2011
    December 2010
    October 2010
    July 2010
    April 2010
    January 2010

    Categories

    All
    401k
    529 Plan
    Asset Allocation
    Behavioral Finance
    Bitcoin
    Bonds
    Financial Advisor
    In The News
    Investing
    Mortgage
    Personal Finance
    Re Balancing
    Re-balancing
    Re-balancing
    Taxes

    RSS Feed

(415) 758-2668
Brian@bootstrapcapital.net                                                                                                                                               
Subscribe
Picture
Copyright © 2020 Bootstrap Capital LLC