Refinancing: A Potentially Healthy Addiction

For people looking to come up with needed money, a cash-out refinance is always tempting. So tempting, in fact, that many people do it repeatedly. One couple, recently featured in a major investment magazine, borrowed their way to huge home equity in tiny increments, with no start-up funds. They borrowed a small amount using a home equity loan, used it to upgrade the bathroom, and watched their home value increase accordingly. They refinanced again, based on their higher equity, and recycled that money to remodel the kitchen. After two years of sweat equity projects-and six refinanced mortgages-their property had doubled in value. They got rich through refinancing home equity wisely.

Whitney whittles away at her fortune

People who borrow more than they can afford, or take money out of their homes without paying it back, can run into trouble. Pop singer Whitney Houston is one very sad example. According to news reports, she bought her primary residence for $2.2 million, with a $1.4 million mortgage. She then used her home equity to buy other homes, eventually borrowing an additional $10 million. But as personal problems took their toll, she used loans to cash-out all her equity and pay extraordinary living expenses and legal fees. This process left her owing millions of dollars in mortgages for real estate that held no measurable equity. Borrowing against home equity, but spending the money to acquire more debt, is a classic and common mistake.

One way to use a second mortgage or home equity loan to get rid of debt is to borrow at an attractive fixed rate and then use the cash to pay off, or consolidate, other high interest loans. For example, if you're paying 18 percent interest on a credit card, and can refinance to an 8 percent home equity loan, you automatically save 10 percent. That rate of return is better than most experts generate in the stock market in a given year, and you can earn it with one phone call to your lender. Plus, the interest and points are tax deductible, saving you even more, and making refinancing a financially healthy habit.