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I'm currently refinancing my house from 4.25% to 2.375%. The loan-to-value ratio is ~67%. (The home value has grown.) My investments give me average returns well above the 2.375% rate. The rates are so low now... I do not expect to be able to refinance with better rate in the future.

I'm thinking about cashing out the mortgage while refinancing and bring loan-to-value to 80%. (BTW, Is 80% LtV usually the maximum I can get without compromising the rates?). I plan to invest most of this cash, probably leaving some for safety. The monthly mortgage payment will still be lower than what I currently pay.

Is there a problem with this idea (invest money from cash-out refinance) that I'm overlooking?

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    Cash-out loans are often more involved, and as noted below may mess with your tax liability / deductions. You might also consider a HELOC to access that equity - they are often low/no fee to set up and have equally low rates.
    – brichins
    Oct 29, 2021 at 19:13
  • You say to lower the rate? Do you get a lower rate if you borrow more? You didn't state in the question.
    – AbraCadaver
    Oct 29, 2021 at 23:04
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    @AbraCadaver "to lower the rate" is why I'm doing refinancing in the first place. Just increasing the loan amount should not lower the rates. The rates can go up though (since the mortgage can become jumbo). Although I've seen cases when good rates on bankrate.com disappear when decreasing the loan amount. Same with Chase. Maybe that was just some technical glitch.
    – Ark-kun
    Oct 30, 2021 at 0:09
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    You can rephrase your question as this: "Would you borrow money at 2.375% in order to invest it, with your house as collateral?"
    – njzk2
    Oct 31, 2021 at 12:53
  • @njzk2 I'm not sure that would be a good rephrasing. My question is as I've stated and I've explicitly focused on the mortgage and refinancing part, leaving investment out of the question. I'm only interested in the possible mortgage and refinancing problems and the specific gotchas. The high-level scheme is clear to me.
    – Ark-kun
    Nov 3, 2021 at 19:15

5 Answers 5

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In the United Sates a cash out refinance isn't fully tax deductible.

This is from IRS Publication 936 (2020), Home Mortgage Interest Deduction

To be fully deducible:

Mortgages you (or your spouse if married filing a joint return) took out after December 15, 2017, to buy, build, or substantially improve your home (called home acquisition debt), but only if throughout 2020 these mortgages plus any grandfathered debt totaled $750,000 or less ($375,000 or less if married filing separately).

Since the mortgage isn't to buy, build or substantially improve the house then this part applies:

Refinanced home acquisition debt.

Any secured debt you use to refinance home acquisition debt is treated as home acquisition debt. However, the new debt will qualify as home acquisition debt only up to the amount of the balance of the old mortgage principal just before the refinancing. Any additional debt not used to buy, build, or substantially improve a qualified home isn't home acquisition debt.

So if you increase the amount of debt you will then not be able to fully deduct the interest on your taxes. Now with the 2017 tax changes few people are able to deduct the interest, but it might be part of your calculus.

I'm thinking about cashing out the mortgage while refinancing and bring loan-to-value to 80%. (BTW, Is 80% LtV usually the maximum I can get without compromising the rates?).

You have to check with your lenders. The cash out refinance is essentially a new mortgage. Which means that they will require Private Mortgage Insurance (PMI) if the LTV is over 80%. The PMI payment might not be deductible.

From the same IRS pub 936:

Limit on deduction. If your adjusted gross income on Form 1040 or 1040-SR, line 11, is more than $100,000 ($50,000 if your filing status is married filing separately), the amount of your mortgage insurance premiums that are otherwise deductible is reduced and may be eliminated. See line 8d in the Instructions for Schedule A (Form 1040) and complete the Mortgage Insurance Premiums Deduction Worksheet to figure the amount you can de- duct. If your adjusted gross income is more than $109,000 ($54,500 if married filing separately), you cannot deduct your mortgage insurance premiums

These numbers are for 2020, so they might be adjusted for 2021.

They also mention that the deduction is for home acquisition debt, but a cash out is a mix of acquisition debt and non-acquisition debt. So that might also limit the deduction.

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    Given the tax law changes of recent years, can most people even deduct mortgage interest? Certainly for me, mortgage interest plus everything else I could possibly use as an itemized deduction is still quite a bit less than the standard deduction.
    – jamesqf
    Oct 29, 2021 at 17:11
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    There will likely also be higher origination fees on the loan, which will offset OP's theoretical gains.
    – brichins
    Oct 29, 2021 at 19:10
  • @mhoran_psprep I was contemplating including a note about tax in my question, but I left it out so that I do not overcomplicate the question. If I understand correctly, there is no difference in interest deduction in my case since even my current loan is above the limit. I can only deduct interest on the first $750,000 in either case. If I understand correctly, the only difference would be in how soon the loan value will go below $750,000.
    – Ark-kun
    Oct 30, 2021 at 0:14
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"My investments give me average returns well above the 2.375% rate."

The problem is a disclaimer that you'll probably see on just about every investment prospectus: "Past performance is no guarantee of future results". Suppose you cash out your home equity, invest it all in the market, and next month the market experiences a worse than 2008 market crash? Which, unlike the relatively quick recovery, lasts for a decade or more, like 1929?

If that happens, then you're stuck with a much higher mortgage payment (because you'd borrowed more money, even if the loan is at a lower rate). You can't really dip into your stocks to make payments, because they've decreased in value so much. Maybe your employer went bankrupt, and you're trying to make that large payment on a much lower salary, so you lose the house too.

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  • And just another note... even "good" stocks may be selling for bad prices, if for no other reason than those are the stocks that actually had value and could be sold to raise funds when the $%!# hit the fan.
    – user12515
    Oct 30, 2021 at 18:04
  • "you're stuck with a much higher mortgage payment" you could specify "than if you hadn't cashed out", because the OP indicated that even with the cash out, the payment will be lower than currently.
    – njzk2
    Oct 31, 2021 at 12:55
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    @njzk2: That seemed obvious to me, but a good point.
    – jamesqf
    Nov 1, 2021 at 1:37
  • Thank you for your advice, but my question explicitly focused on the mortgage and refinancing part, leaving the possible investment out of the question. The high-level scheme is clear to me and I understand the investment risks. There are many gotchaswith mortgages and refinancing and that's what I'm interested in.
    – Ark-kun
    Nov 3, 2021 at 19:17
  • @Ark-kun the question explicitly asked if there’s a problem. Well, this is a problem. If you get laid off, you still have to pay that higher mortgage. Bottom line: debt is risk, and one which should be reduced without substantial guarantee of success.
    – RonJohn
    Nov 6, 2021 at 13:32
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As long as you can acknowledge that you are taking a risk that you can beat a 2.375% (minus any taxes you pay on your housing refi gain), you're getting a good deal. And 2.375% isn't a hard number to beat - even inflation is beating that number right now!

Having said that, a better move might be to use this loan for debt consolidation, if you have any. Almost any other debt you have is going to be higher than 2.375%, and is likely also going to be higher than any returns you can get. You haven't said anything about your debt load, but that's likely the better move if applicable.

And try not to second guess yourself. You're in a great position by being able to do this.

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  • Thank you for your advice. I currently do not have any other debts. >"minus any taxes you pay on your housing refi gain": Hmm. Can you elaborate on this? I thought that the cash-out part is not taxed, since I'm just getting a big loan and paying off an old loan. What is considered gain here and how is it taxed?
    – Ark-kun
    Oct 30, 2021 at 0:18
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    I may be a little salty, but 2.375% is impossible to beat without taking on risk right now.
    – user12515
    Oct 30, 2021 at 18:02
  • Re "even inflation is beating that number right now!", sure, but next year? 5 or 10 years from now? To be a low-risk investment, it has to a) beat the mortgage rate over the life of the mortgage; and a) not drop so far at any point in that lifetime that the OP is forced to sell the investments at a loss.
    – jamesqf
    Oct 31, 2021 at 1:37
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I would be concerned that once I've raised my loan to 100% LtV, there might be an unforeseen event that causes home prices to drop, causing you to be "upside-down" on your mortgage. This may not be financially difficult for you, but it does limit your freedom to be able to sell your home.

A lot of people back in the early 2000s thought this would never happen to them, till it did. At that time, however, people were buying homes at nearly 100% LtV, and financing them with Adjustable Rate Mortgages. When housing prices dipped, and people got stuck with those adjusting ARM rates, foreclosures started, and those foreclosures had the spiraling effect of drawing down the prices of other homes in the area (due to appraisal comps), it created a vicious cycle.

My point is not that a similar scenario is likely to happen to you, just that when you're determining your tolerance for risk, you can't just look at the numbers, you have to project future economic, social, and political events when it comes to real estate decisions.

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Does it make sense to cash out all home equity when refinancing for other reason?

No, but it probably makes sense to go up to 80% LTV. Not because you can't get the same rate if you go higher, but because above 80% you enter in the realm of PMI which makes it much harder to win the bet (that you can invest and beat 2.375% + any potential taxes offset.)

Even if you itemize, after considering you may not be able to fully deduct the new higher loan amount, I would treat this as a bet that you can invest and beat 3.5-4% per year on average to make it worth it. An exception to this would be if you aren't currently putting money into a Roth, and if doing this would enable you to (either directly or backdoored), then you would just have to beat 2.375%. Either way, historically this would be a fantastic bet over a 15-30 year mortgage time frame.

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