Should you do a cash-out refinance before retirement?

Erik J. Martin
The Mortgage Reports contributor

In this article:

  • What can you accomplish with a cash-out refinance before retirement?
  • How can it help your financial position?
  • What are the drawbacks?

Like most mortgage products, the cash-out refinance is not good or bad. It’s either appropriate or not. Here’s how to decide if a cash-out refinance before retirement is a good strategy.

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Consider a cash-out refinance before retirement

Own a home in your fifties or older and still have a mortgage? Maybe you should consider a cash-out refinance before retirement. This option could offer some flexibility:

  • Use the extra money to invest in your retirement savings, make a large purchase, or remodel your house
  • You may pay less if you opt for an adjustable rate mortgage and plan to move soon
  • It can enable you to pay down other high-interest debt and streamline all home loan payments

Related: Best uses for a cash-out refinance

This strategy has its drawbacks, too. You’ll be retiring with extra debt. The costs may outweigh the benefits. And tax consequences may apply. So weigh your choices carefully. And consult with lender, tax, legal and estate planning experts before taking the plunge.

Cash-out refinance pros

If you’re nearing retirement, but still pay a mortgage, refinancing that loan may be a smart move. That’s especially true if you can get a better interest rate or loan terms.

But it may also make sense to tap into your equity and with a cash-out refinance before retirement. This can:

Improve your cash flow. That extra money can help fund a remodel, auto purchase, tuition, medical bills, and more. “For example, maybe you need a remodel in the next few years. Well, you may want to take care of it now. That’s because you may have a harder time qualifying for a refi or home equity loan later,” says Jennie Jacobson, mortgage loan consultant with Orange County’s Credit Union.

Possibly lower your monthly payments. Plan to move within a few years? Then it may pay to refinance to an adjustable rate mortgage that offers a low introductory rate period. This period should match the time you plan to remain in the house.

Help you save for retirement. You can use the cash-out money to invest in your retirement savings through a 401(k), IRA or another plan. “It’s fine to take cash out of your home at low rates if you can reinvest that cash at a higher rate,” Realtor and real estate attorney Bruce Ailion “But to borrow at around 5 percent and reinvest in something like Treasury notes at 3 percent doesn’t make sense.”

This can be risky at a time when most experts advise safer investments that preserve your capital, rather than aggressive ones that can pay more but also lose big.

Consolidate and pay off debt. You can use the extra cash to pay down other high-interest debt. “Your cash flow can improve if you eliminate unsecured credit card debt. That’s because this kind of debt usually has high monthly payments,” Jacobson says.

Cash-out refinance cons

Taking money out during a cash-out refi isn’t a foolproof plan.

It can cost more than it’s worth. Refinancing involves closing costs. These can equate to around two to five percent of the loan amount. Experts advise avoiding a refi if you expect to sell your home within five years.

You may need to move sooner than you think. “I find many retirees and pre-retirees are in homes that are not ideal,” says Ailion. “The home you bought 10 or 20 years ago may not include aging-in-place features that will allow you to live comfortably. Before taking on more debt, evaluate where you want to live and what your needs are.”

Related: Guide to mortgage closing costs: Average mortgage costs and how to keep yours low

You may be in debt well into retirement. Let’s say you’re 60. If you take out a new 30-year loan, it won’t be paid off until you’re 90. If you don’t make it that long, your heirs are on the hook to pay off the mortgage.

Other drawbacks

There’s more to think about, too. With a cash-out refi:

The interest may not be tax deductible. “Interest on cash-out refis are now deductible only if the money is used for home improvements. Assume you use the cash to pay off old debt or supplement retirement income. In this case, you won’t be able to deduct the interest from your taxes,” says attorney Elizabeth A. Whitman. She notes that this applies only if you itemize your tax deductions.

It may impact your Medicaid eligibility. “Maybe you have limited income and are facing medical issues or nursing home care. Cash in the bank from a cash-out refi is not exempt,” adds Whitman. “It needs to be spent on eligible living expenses or medical care before you are eligible for Medicaid.”

You may get hit with a prepayment penalty. Some mortgages slap on fees if you prepay before the term expires. Check your loan documents carefully.

Extra matters to ponder

Worried about resetting your loan to a longer term? Not sure you can afford the monthly payments on a shorter-term loan? There’s no shame in choosing a 30-year fixed loan.

“You can always pay extra each month or year to pay off your loan more quickly if you have the extra money to do so,” suggests Jacobson. (Check that there’s no prepayment penalty first.)

Remember: choosing a 10- to 15-year loan can result in higher monthly payments. “And that may not be affordable after you retire,” Jacobson says.

Related: Refinance without restarting the clock on your mortgage repayment

Also, if you plan to sell your home shortly after refinancing, don’t sweat it.

“You can choose to sell whenever you want to,” notes Jacobson. “But there may be an early termination fee or pre-payment penalty for some loans. Ask your lending expert about products that are better for the short-term. These can have a slightly higher interest rate but no closing costs.”

If you own your home outright, or have a lot of equity but are strapped for cash, and are at least 62 years old, check out a reverse mortgage. This provides quick cash by permitting you to borrow against your home’s equity. If you lack sufficient income, a reverse mortgage may be easier to qualify for than a cash-out refi.

Make an informed choice

The good news is that lenders cannot discriminate against you based on your age.

“But they can underwrite based on income and ability to pay back the loan,” says Whitman. “Let’s say you have a lower income today. Then the amount of loan you may qualify for could be smaller and on less favorable terms.”

For these and other reasons, get advice before making any lending decision. Determine if your new mortgage payment will strain your budget once you retire.

“Talk to a loan officer, CPA, and investment professional,” recommends Jacobson. “The most important question to ask is: Is this loan better than the loan I have now? If the answer is yes, you can evaluate the costs and feel more confident about your decision.”

Verify your new rate (Aug 14th, 2020)