By Bob Rinear
CEO Investyourself.com

Every day you hear and read about record low interest rates and that you should rush out to refinance your mortgage. Is this true, and just what should one do about their mortgage? Lets chat about it for a minute.

Mortgage debt takes the biggest single bite out of your family income. With home prices at near record levels, even a low interest rate doesn’t change the fact that your home will be your single biggest expense. Naturally lowering that expense makes perfect sense, but there are some guidelines you should take into account.

Lets suppose that right now you are locked into a thirty-year mortgage and you are paying 7.5% on that loan. Well, now that interest rates are so low, it’s easy to get a 6% mortgage. The difference of that 1.5% is very substantial, and could amount to a couple of hundred dollars per month or more, depending on how large the loan is for. So what could possibly be wrong about lowering your monthly payment? Nothing. In fact it’s one of the wisest things you can do.

But here is where I part company with what you are reading in the newspapers or on Bubble vision TV. In NO WAY do I think it is a wise move to take equity out of your home! In other words, don’t ever do a “cash out” refinance. What is a cash out? Simple, it’s where you take out more money than the existing loan is for. Let me give you an example. Suppose you bought a house for $150,000, and now you have a balance of about $100,000. Because homes have appreciated in the past three years, the bank says your house is worth $200,000. Most people will look at that “value” sitting there and decide that when they refinance they should take some money out. So, instead of just refinancing for the $100,000 and reaping the benefit of the lower payment, they refinance for $150,000, $170,000 and in some cases the full $200,000 dollars.

On the surface that seems great! Chances are that they just put many thousands of dollars in their pocket and yet their monthly payment did not increase. So, most people think it is a wash and they go out and blow the money on new cars, boats, pools, vacations, you name it. As long as they can meet the monthly mortgage, they assume they have just made a wise move. But I argue.

What’s wrong with using your home like an ATM machine? Many things folks, and you must consider them carefully. First, if you have paid 10 years into a 30 year mortgage, and then you refinance for another 30 years, you have just “started over” for yet another 30 year term. Ownership is now 30 years away again. Now that’s not terrible, especially if you figure you will be selling before that, but then we have the problem of equity in the home.

Lets suppose you owed 100K, but you refinanced for the whole 200K they say it’s worth now. That put 100K in your pocket and you feel a lot richer, but this only works if home prices remain stable or even rise. What happens if the economy cools even further and housing prices fall a bit? Worse yet, what if interest rates rise and the housing market really comes to a grinding halt? Now we have a problem.

If housing prices were to just stall out and fall by 10% that has happened dozens of times over the past decades, a 10% fall on a 200K dollar house is 20 grand. If you are mortgaged for 200, but it’s only marketable for 180, you are “locked in” that house. You can’t sell it without taking a hit. What if prices were to retreat 15 to 20%? You’d be looking at quite a shortfall.

Some will argue that you have the money you extracted, so if you had to sell, you’d just make up the difference. Baloney! You took that money out to “blow” on “stuff” You probably bought a car, boat, pool, cruise, or a combination of all the above. Surveys show that the average person that does a cash out refinance has less than 10% of the money left in just 14 months. This is a very dangerous situation to be in, and we don’t recommend it. What is the sense of taking out cash on a thirty-year loan to buy goods that will be obsolete in 10? That new 15 thousand dollar home theatre system sure sounds good today, and as we know it will be yesterday’s news in a few years. Yet you will be paying on it for 30 years. The same scenario applies with a car, or a boat. 99% of the things we buy depreciate in a short period of time, but your mortgage payment won’t. It will remain constant for 30 years. That cruise you enjoyed so much for 10 grand will be a distant memory as you spend the next 27 years paying for it.

So what should you do? Simple. Get the lowest rate you can possibly get and then “save” the difference. If you were paying $1,000 per month and now you are paying $750.00, take the $250.00 difference and put it in a simple savings account. Now that will fly in the face of Wall Street Hipsters too as they tell you it’s insane not to have it fully invested. Baloney. How good has Wall Street been at investing lately? Over the past three years, 95% of all mutual funds are still underwater, yet they say invest. Please.

Put your $250.oo a month in a local savings bank and keep adding to it each month. If you were paying $1,000, you are accustomed to it. At the end of just one year you will have $3,000 in that account. (without any interest gains). In just 3 years of doing that you can go on that 10K dollar cruise and it’s all paid for up front. Cash.