Cash-Out Refinancing: Check It Out Carefully

ENDNOTES

1

Data are from the Mortgage Bankers Association.

2

This mortgage requires you to make monthly payments of $733.76 each month for 30 years, with an option to refinance without penalty at any time. Transaction costs to refinance a mortgage may amount to a few thousand dollars. The monthly payments contain a small amount of principal repayment, or amortization, at the beginning and a progressively larger principal repayment as time passes. The remainder of each monthly payment represents interest on the remaining principal outstanding.

3

We assume this household does not itemize deductions on its income-tax return; so, the deductibility of mortgage interest is irrelevant to its financial decisions. Less than 28 percent of taxpayers claimed the mortgage interest deduction in 2001 (Internal Revenue Service, 2005), and most of those that do are in relatively high marginal-tax-rate brackets because they have above-median incomes ($42,400 in 2002; U.S. Department of Commerce, 2002).

4

The household could invest all of the cash-out proceeds to supplement the income needed to meet future mortgage payments, but this strategy is risky unless the investment is guaranteed. Unfortunately, it is impossible to earn a guaranteed return as high as the interest rate on the borrowed money. However, paying off other debt that bears an interest rate higher than 6 percent would be an efficient and risk-free use of cash-out refinancing proceeds.

REFERENCES

Internal Revenue Service, “Historical Tables and Appendix,” Statistics of Income Bulletin, 2005. See www.irs.gov/taxstats/article/ 0,,id=115033,00.html.

Mortgage Bankers Association, “Weekly Application Survey.” See www.mbaa.org/marketdata/.

U.S. Department of Commerce, Bureau of the Census, “Current Population Survey, 2002.” See www.census.gov/hhes/www/img/ incpov02/fig02.jpg.