February 24, 2009


Title: Are refinancing takeouts yesterday’s new?

Sub-title: During tough economic times, consumers often focus on debt pay-downs. But that strategy is not for everyone.


One of the fallouts of the current economic and credit crisis is how it is changing consumers’ attitudes toward debt. Gone are the days when people borrowed and spent unthinkingly, their main worry being whether they could make their minimum payments next month.


For example one once-popular habit among American consumers – using rising house values to borrow a bit of extra cash when they refinance their mortgages -- has all but stopped. This should not come as a big surprise. According to the Case-Schiller housing index, house prices in major U.S. markets fell by 18.5 percent in December compared to one year earlier, the fastest drop on record. 


Here in Canada, the picture is somewhat different. True, house prices are sliding, but not as fast as they are south of the border. Even more surprising, according to a study by the Canadian Association of Accredited Mortgage Professionals, the average amount taken out by those who make withdrawals when refinancing their mortgages actually increased last year.


According to CAAMP data, about one in five borrowers took out more cash with their refinanced mortgage last year, with the average draw rising by 20 percent to $41,000. This surprising result begs the question: do those re-financers know something that the rest of us do not?


Refinancing in tough times

The first thing to remember about any financing strategy is that no one course of action is best for everyone. In fact, for many consumers, a strong case can be made that taking out extra cash when refinancing a mortgage can be a good thing.


According to Jim Murphy, president of the Canadian Association of Accredited Mortgage Professionals, 56 percent of those surveyed in its study who took out extra cash when re-financing their mortgages used the funds to consolidate their debt, while 30 percent used the funds to finance home repair and renovation.


Gary Siegle, a regional manager at the Calgary office of Invis, a mortgage brokerage firm, says that the data are not surprising. “Interest rates charged on most forms of consumer debt are much higher than those charged on mortgages,” says Siegle. “For example the major credits cards charge about 18 percent on outstanding balances. With departments stores credit cards the rates can be even higher.”


The fact that mortgage rates are at historical lows, makes the debt consolidation strategy even more attractive than it would be in normal times, says Siegle. “Five-year fixed mortgage rates are now at 4.39 percent and three-year rates are at close to 4.2 percent. So from a simple standpoint of saving money the strategy has clear advantages.”


But is refinancing a good idea?

That said, Siegle cautions that consumers need to be cautious. “If you take credit card debt and roll it all over into your mortgage, what you are effectively doing is paying off current purchases over 25 or 30 years, depending on how long the maturity is,” says Siegle. “While that may make sense if you do it as a one shot deal, it is not a habit that you want to get into.”


Furthermore Siegle says, refinancing has costs attached to it ranging from lawyers fees, to various taxes, which can vary between just a couple of hundred of dollars to up to $1,000 and in some cases even more.


Jean-Francois Vinet, a financial services analyst at Option Consommateurs, a Montreal-based consumer rights organization, agrees that debt consolidation can be a good thing, but counsels that is cannot be looked at as a standalone strategy. “Not being able to pay off existing liabilities and being forced to roll them into your existing mortgage is a clear sign that you are spending too much money,” says Vinet. “As a result, you should almost certainly sit down and work out a feasible budget.”


Vinet agrees that taking out cash when refinancing a mortgage can be a good idea in certain circumstances. However the organization generally counsels against it. “Don’t forget that interest costs are typically the single largest cost of owning a home,” says Vinet. “So you want to keep those costs down.”


According to Vinet, a home buyer who finances a typical $200,000 purchase at 6.0 percent interest rate over 25 years, will pay almost as much in interest over the life of the mortgage as he will in principal. As a result, he counsels even those who borrow money for home renovations ought to think twice about it, when spending on what he calls “luxuries” such as swimming pools. In fact Vinet even looks down on borrowing to pay for kitchen and bathroom renovations, investments that many experts say adds value to a home.


“If you spend $10,000 on a new kitchen and it boosts the resale value of your home by $5,000 is a it a good investment?” asks Vinet. “If you want to renovate, we have nothing against it. But you should save the money first, before you spend it.”




Peter Diekmeyer (peter@peterdiekmeyer.com is a Montreal-based freelance business writer.





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