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Refinance to the Max? Flaw in my Logic?

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  • Thu, Mar 12, 2009 - 06:36pm

    #1

    Lemonyellowschwin

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    Refinance to the Max? Flaw in my Logic?

These thoughts are inspired by the long and involved thread (originally from Erik Townsend) titled "Get out of Debt!  Bad Advice?"  I’d appreciate it if anyone could find a flaw in my logic.  Basically, my question is this:  If the advice "Get out of Debt!" is bad, then isn’t the corollary also true — that I should get into as much debt as possible (assuming it is low interest debt)?

Assume I live in a house worth about $500,000.  (At the peak of the market it was probably worth about $600,000.)  Assume I have a $300,00 mortgage at 5.3% interest and a high income and plenty of assets and have no problem making the payments.  My question is whether I should take this opportunity to refinance the house at about the same interest rate, but taking the mortgage up to about 80% or 90% of value instead of the 60% where it’s at now.  I could invest the money that I "take out" in some very conservative short term investment like a shorter term FDIC-guaranteed CD paying 1%.  As long as interest rates remain low, I would be losing about 4% a year for the privilege of having cash instead of equity.  Thus, the maximum downside is the loss of about 4% on my money.  (Note that I have no intention whatsoever of spending the money.)

Consider the following:

 1.  If inflation and interest rates rise, my return on even something like a short-term CD will increase.  If, as I predict, inflation rises substantially my investment might eventually return more than my mortgage interest and would therefore be making money.  (Note that I am trying to be as conservative as possible.  If I knew we were going to have high inflation I would put the money into an inflation hedge right away.  If I was positive we were going to have high inflation, it seems like taking out the maximum amount of money at about 5% interest and putting it in an inflation hedge would be a no brainer).

2.  If my house value continues to decline and I eventually find myself underwater I can walk away from the house at any time, leaving the bank holding the bag.  My credit score gets ruined (I don’t care) but on a non-recourse loan they cannot come after me for any excess.  It seems to me that maxing out my loan-to-value ratio is practically insurance against a continuing substantial decline in the value of my house.

3.  I live in the city.  While I love where we live, the potential for civil unrest is in my mind.  If we ever have a true SHTF scenario I would rather have cash than equity in this situation so that I could pack up and leave.  In a situation like that, selling the house becomes impossible and I forfeit any equity I have.

4.  If circumstances warranted it, I could change my mind whenever I wanted and put the money back into paying off the mortgage I took out.  On the other hand, the opportunity to refinance the house to the max at historically low interest rates might not be around forever.

Long story short, I don’t want to sell the house for many practical reasons and the fact that it is an expensive and time consuming process.  But it seems like converting the equity into cash at 5% interest makes sense practically no matter what comes to pass so long as I am not going to spend the money.  It’s insurance against substantial depreciation;  it’s a money making opportunity in the event of substantial inflation; and its insurance against a SHTF scenario.

Long story short:  Why do I want to have any equity?????

  • Thu, Mar 12, 2009 - 06:56pm

    #2
    Peak Prosperity Admin

    Peak Prosperity Admin

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    Re: Refinance to the Max? Flaw in my Logic?

I want to know where Erik came up with the idea that the majority of mortgages held by the larger institutions are Non-recourse loans? About 95% of the loans I see at Wells Fargo are recourse loans. They are limited recourse loans which allow the lender to take assets only at Wells Fargo to cover the debt owed.  I would not want people here to think that the bank will not take funds to cover the debt. By law they have to leave only a dollar in the account.

  • Thu, Mar 12, 2009 - 07:13pm

    #3
    Peak Prosperity Admin

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    Re: Refinance to the Max? Flaw in my Logic?

Lemmon I am with you, I would take all the money I could get my hands on at these low interest rates and put them in investments.  I am a law student in my final semester and I have taken out all the student loans I could, and I have invested them in gold and silver.  If you know what you are doing, then by all means take adavntage and make that equity work for you.  You could easily be mortgage free in a couple of years. Remember there is a difference between good debt and bad debt.  Good debt puts money in your pocket, bad debt takes money from your pocket. 

  • Thu, Mar 12, 2009 - 07:49pm

    #4
    Peak Prosperity Admin

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    Re: Refinance to the Max? Flaw in my Logic?

I’m pretty sure that in certain states, mortgages are recourse, and the bank can come after your other assets.  Unfortunately, I live in one of those states (Ohio).

  • Thu, Mar 12, 2009 - 08:04pm

    #5
    Peak Prosperity Admin

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    Re: Refinance to the Max? Flaw in my Logic?

I’ve run through some similar thoughts on debt vs equity in house but still have lots of questions I might think through before making a such a move. 

Will the bank let you finance that close to full value? 

What if inflation and rising interest rates don’t occur for many years?

Is the risk of ruining your credit score acceptable?

What are the advantages and disadvantages of another alternative:  selling your home for cash, investing the cash, and renting a place you walk away from much more easily?

Is real estate just as good or even safer inflation hedge than other investments?

If SHTF, would you be able to access your cash?

If you have cash in the bank, does that increase the risk that someone else could take that liquid asset if you fall behind on bills.  Does it make you less likely to qualify for something like say student financial aid or medicare?

can you really be disciplined enough not to spend the cash?

If you decide to put the money back into the mortgage later, you’re still stuck paying interest per the original amortization schedule until the loan is fully paid, which means more intestest paid total than if you had kept a lower morgtage.  Plus the cost of refinancing.  Is it worth the cost of "insurance"?

Compare to a home equity line of credit.  Interest rate might be variable, but you can also pay back anytime also.

  • Thu, Mar 12, 2009 - 08:13pm

    #6
    Peak Prosperity Admin

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    Re: Refinance to the Max? Flaw in my Logic?

You might find that banks are reluctant to do ANY cash out re-finances at this time.  I re-financed last April, had more than enough equity, and a FICO of 799.  I was told they wouldn’t do much, if any cash out, which was fine by me because I just wanted to lower my rate and go to a 15 year from a 30 with 20 remaining.  But if they balked at any cash out then, I can imagine what they’re thinking now.

  • Thu, Mar 12, 2009 - 10:15pm

    #7
    Peak Prosperity Admin

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    Re: Refinance to the Max? Flaw in my Logic?

[quote=Lemonyellowschwin]

(Note that I am trying to be as conservative as possible.  If I knew we
were going to have high inflation I would put the money into an
inflation hedge right away.  If I was positive we were going to have
high inflation, it seems like taking out the maximum amount of money at
about 5% interest and putting it in an inflation hedge would be a no
brainer).[/quote]

Since I am planning to buy gold to preserve my meager assets from the inflation I am convinced is coming, I am intrigued by your comments above. What are you planning on doing for an "inflation hedge"?

  • Fri, Mar 13, 2009 - 12:59am

    #8
    Peak Prosperity Admin

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    Re: Refinance to the Max? Flaw in my Logic?

Dan Amerman http://mortgagesecretpower.com/ is a big advocate of this premise. I found him from a post in Erik’s original post.

 

Lots of ways to go to hedge your bets.

 

I’m fearful that what Ragner said is true. In my case I have a paid off house. I would like to get 50 to 70% cash out, but I’m fearful that no lender will touch it right now. But I haven’t checked into it yet due to procrastination.

  • Fri, Mar 13, 2009 - 03:31am

    #9
    Peak Prosperity Admin

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    Re: Refinance to the Max? Flaw in my Logic?

[quote=Lemonyellowschwin]

These thoughts are inspired by the long and involved thread (originally from Erik Townsend) titled "Get out of Debt!  Bad Advice?"  I’d appreciate it if anyone could find a flaw in my logic.  Basically, my question is this:  If the advice "Get out of Debt!" is bad, then isn’t the corollary also true — that I should get into as much debt as possible (assuming it is low interest debt)?

Assume I live in a house worth about $500,000.  (At the peak of the market it was probably worth about $600,000.)  Assume I have a $300,00 mortgage at 5.3% interest and a high income and plenty of assets and have no problem making the payments.  My question is whether I should take this opportunity to refinance the house at about the same interest rate, but taking the mortgage up to about 80% or 90% of value instead of the 60% where it’s at now.  I could invest the money that I "take out" in some very conservative short term investment like a shorter term FDIC-guaranteed CD paying 1%.  As long as interest rates remain low, I would be losing about 4% a year for the privilege of having cash instead of equity.  Thus, the maximum downside is the loss of about 4% on my money.  (Note that I have no intention whatsoever of spending the money.)

Consider the following:

 1.  If inflation and interest rates rise, my return on even something like a short-term CD will increase.  If, as I predict, inflation rises substantially my investment might eventually return more than my mortgage interest and would therefore be making money.  (Note that I am trying to be as conservative as possible.  If I knew we were going to have high inflation I would put the money into an inflation hedge right away.  If I was positive we were going to have high inflation, it seems like taking out the maximum amount of money at about 5% interest and putting it in an inflation hedge would be a no brainer).

2.  If my house value continues to decline and I eventually find myself underwater I can walk away from the house at any time, leaving the bank holding the bag.  My credit score gets ruined (I don’t care) but on a non-recourse loan they cannot come after me for any excess.  It seems to me that maxing out my loan-to-value ratio is practically insurance against a continuing substantial decline in the value of my house.

3.  I live in the city.  While I love where we live, the potential for civil unrest is in my mind.  If we ever have a true SHTF scenario I would rather have cash than equity in this situation so that I could pack up and leave.  In a situation like that, selling the house becomes impossible and I forfeit any equity I have.

4.  If circumstances warranted it, I could change my mind whenever I wanted and put the money back into paying off the mortgage I took out.  On the other hand, the opportunity to refinance the house to the max at historically low interest rates might not be around forever.

Long story short, I don’t want to sell the house for many practical reasons and the fact that it is an expensive and time consuming process.  But it seems like converting the equity into cash at 5% interest makes sense practically no matter what comes to pass so long as I am not going to spend the money.  It’s insurance against substantial depreciation;  it’s a money making opportunity in the event of substantial inflation; and its insurance against a SHTF scenario.

Long story short:  Why do I want to have any equity?????

[/quote]

Take the equity out… because you can still put it back in later (only if you trust yourself NOT to touch it)– put the $ in high-yield CDs.

To me, that is the smartest move because YOU NEVER KNOW if you’ll be able to pay the other $300k.  You also don’t know if/when TSHTF you’ll have any $$ when you lose a bulk of your value of the house, and etc.  When you get closer to 15/20 years then dump the money on your mtg.  Think about the idea of your house being paid off???  That’s your goal (IMO).  Every month, if you can, I would make an extra 10% towards principle (even when the equity is pulled out).  The extra 10% helps lessen the compounding, i.e., shaving off years, and lowering principle (sorry– don’t know how to write this well enough).

 

  • Fri, Mar 13, 2009 - 03:31am

    #10
    Peak Prosperity Admin

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    Re: Refinance to the Max? Flaw in my Logic?

" If inflation and interest rates rise, my return on even [something like] a short-term CD will increase."

Isn’t a CD a fixed rate instrument? If so, the opposite of the above would be true.

Ted

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