Equity Gains + New Tax Law = Cash-Out Refinance?

Rising home prices across the country and consistent mortgage payments driving down the amount owed on a home mortgage amount means homeowners are realizing even more equity in their homes. This home-equity is often an attractive source of funds for paying off higher-interest debt and realizing tax-advantages under the mortgage interest deduction.

As we covered in our previous article, the Tax Cuts and Jobs Act of 2017 eliminated the mortgage interest deduction for home equity loans—unless they are “used to buy, build, or substantially improve your property.” Meaning, a home equity loan used to pay off credit card or other debt is no longer tax deductible. But, if you refinance your primary mortgage loan through a cash-out refinance, the entire amount is still tax deductible up to $750,000. This rise in equity coupled with record levels of outstanding student loan and credit card debt and changes to the tax code—could still make consolidation through a cash-out refinance a good move for some borrowers, even if it means taking a higher interest rate on your mortgage.

Lower Interest Rates

The biggest incentive for a borrower to consolidate their debt with a cash-out refinance is to get a much lower overall interest rate. Today the average fixed rate for a 30-year refinance is hovering around 4.62%, while the average revolving credit card rate is 16.81%, and the average student loan rate is between 5-7%, though some debts may have additional terms that make the payoff less wise and a borrower should speak with their financial advisor before making a decision. It’s easy to see how absorbing high interest loans into your home loan could save some serious cash, but it also has the added benefit of creating a clear trajectory and payment plan to effectively eliminate debt.

Closing Costs Vs. Mortgage Interest Deduction

You will have to pay closing costs on your cash-out refinance. Closing costs vary widely, with the average amount for a refinance in America being around $4345. In some instances, closing costs can outweigh the benefits of consolidation. But, by shopping around for a lender that won’t charge unnecessary fees, and using a low-cost title company (like Spruce), these costs can be kept in check.

For example, with a $350,000 loan, the first year of tax savings are estimated at around $5,932.

Meaning, if your closing costs hover around the average rate, the mortgage interest deduction could effectively cancel the closing costs out in the first year. This benefit can make cash-out refinancing an even more attractive vehicle for eliminating high interest debt than a HELOC—since these loans are now only tax deductible if used to make improvement to your home and also incur closing costs. It is also important to note that closing costs are a fixed, one time expenditure—while with a cash-out refinance—you reap the benefits of the mortgage interest deduction and potentially lower interest rates over the entirety of the loan.

The Bottom Line

Consolidation of debt through a cash-out refinance can be an effective tool for paying off your high interest loans and creating a clear plan to reduce your overall debt. However, it’s important to keep in mind all of the potential risks and costs associated with tying up multiple loan accounts into one home loan. When used correctly, cash-out refinancing even into a higher interest rate mortgage can prove to be a practical and savvy financial method for eliminating the burden of high interest loans.

  • As always, borrowers should consult with their financial advisors to determine the best path for them. Nothing contained herein should be considered tax advice or legal advice.