Homeowners who refinance opting to take equity as cash

It's an eyeball-grabbing number for anyone interested in real estate: Nearly three out of four homeowners who refinanced through Freddie Mac between July and October cashed out, walking away with what was often thousands of dollars of tax-free money.

Cash-out refinancing is hardly new, but the proportion of refinancers now using the technique to pay for consumer expenses or investments — 72 percent — is at its highest level in more than five years. One key reason for the trend: Compared with the spiraling costs of home-equity credit lines, fixed-rate cash-out refis into 30-year or 15-year mortgages now look smart.

Some equity credit lines carried starting rates below 4 percent a year ago. Today, a typical "prime-plus-one" (prime bank rate plus 1 percent) credit line starts at 8 percent. If, as expected, the Federal Reserve Board keeps bumping short-term rates upward in the months ahead, equity lines could float into the mid-8 percent range or higher.

Contrast that with a fixed-rate cash-out. Say you need $100,000 for a down payment on a second home or to fund a business venture.

Say you've also got at least $300,000 in net equity in your house, cream-puff credit scores, and you qualify for the lowest fixed rates. You should be able to find a 30-year fixed-rate refi in the 6 to 6.25 percent range, or a 15-year fixed rate in the 5.5 to 5.75 percent range.

Because you've got loads of equity, your lender should have no objection to a cash-out refi giving you the $100,000 you want.

Cash-out refinancing has another strong point now: Long-term interest rates appear to be headed for a slow but steady rise. Locking in 6 percent today may look like a brilliant move a year or two down the road, when rates could be significantly higher.

If you do opt for a refi rather than a floating-rate equity line, you will have lots of company.

Freddie Mac chief economist Frank Nothaft predicts that homeowners will pull a stunning $204 billion from their properties this year alone by refinancing their primary mortgages. During the quarter from July to October, $60.4 billion in equity was turned into cash through refinancing, Nothaft said.

What are the downsides of cash-out refinancing? A few are obvious:

• You carry more debt secured by your house, which puts your most important asset at greater risk if you lose your job, get sick or run into other financial difficulties.

• More debt also means higher monthly payments, especially if you opt for a 15-year payback term. Can you handle the extra monthly burden? Do you have reserves or contingency plans to manage your monthly mortgage, credit-card and other consumer-debt payments?

• Refinancing typically costs much more in settlement and loan-origination fees than home-equity lines, unless you have your closing charges rolled into the note rate.

To be fair, home-equity lines are by no means obsolete in today's market, where short-term rates are rising faster than long-term rates. There are several good reasons to strongly consider an equity line:

• At the top of the list would be convenience and control. Once you've been approved for a specific amount on a line, it is totally your call as to how much you draw down and when you actually receive the cash.

• You pay interest on only the amounts you've pulled out, not the approved limit.

• Most lines allow immediate access to more money using credit cards or checks. Normally there is no hassle in getting more money up to the credit-line limit.

A $100,000 credit line may be a far more flexible financial management tool for you than a $100,000 lump-sum cash-out refi. If you need to use only $20,000 of the $100,000, that's all you get. The $80,000 balance functions as a cost-free contingency fund — ready for action whenever you truly need it.

Your monthly rate on your $20,000 may be 8 percent, but the rate on your contingency balance is zero percent.

Finally, don't forget that a growing number of banks allow you essentially to have your cake and eat it too: You can convert your floating-rate equity line into a fixed-rate equity loan or second mortgage whenever you choose.

You can float your rate for a while on modest balances, then lock in for the long term if you borrow a lot of money.

Kenneth R. Harney: kenharney@earthlink.net