A Gift From Your Home to You: Cash Through Refinancing

Could your biggest holiday gift be hidden away not under your tree, but somewhere you hadn’t thought to look--your house itself? Could you use an extra $20,000 to $30,000, tax-free?

Then gather ‘round the fire to learn of this extraordinary end-of-the-year cheer: Thanks to tumbling mortgage rates, high real estate appreciation rates and generous new loan financing limits from Freddie Mac and Fannie Mae, you may be able to pull substantial cash out of your home equity during the coming few weeks.

You can use the tax-free money for whatever you like: a vacation in Europe where favorable exchange rates stretch your dollars further than ever right now. A new car. College tuition bills. A down payment on a place at the beach.

Mortgage interest rates have dropped significantly in December, and are now at a point--verging on 7.25% for 30-year money--where refinancing could make sense for you.

Robert van Order, chief economist at Freddie Mac, the giant home loan investor, says that mortgage rates have been following the bond market’s lead downward in recent weeks. Part of the reason: widespread expectations of lower rates early next year because of the slowing economy, and possible moves by the Federal Reserve to push down rates even further.

Doug Duncan, chief economist of the Mortgage Bankers Assn. of America, believes “the economy is slowing a lot faster than almost anybody expected.” He cites softness in auto sales, computer sales, corporate profits and the early signs of higher unemployment. Average home mortgage rates, which topped out at 8.6% for 30-year loans last May, dropped nationwide to 7.4% last week. But in many markets, 7% to 7.25% is readily available to borrowers with good credit histories.

A Chance to Pull Out Increased Equity

All of which opens the door to a financial move you may not have contemplated. Why not take advantage of the sweet combination of economic forces underway to refinance your mortgage and to pull out some tax-free loot to boot?

Me, you ask? Yes, you, even if you think your current interest rate isn’t all that bad. Consider this scenario. Say you’ve got an 8% $175,000 fixed-rate mortgage. You bought your house for $200,000. Thanks to appreciation, it’s now worth $250,000.

Your current principal and interest payments come to about $1,285.50 a month. Your equity has grown from roughly $25,000 to $75,000. If you have good uses for $25,000 cash right now, you could do the following: Refinance into a 7.25%, 30-year mortgage, and pull out an extra $25,000--giving you a new loan balance of $200,000. Your monthly principal and interest payment would come to $1,364--just $78.50 above your current payment. And if you shopped even more vigorously and found a 7% loan, your monthly principal and interest would come to $1,330--or just $44.50 over your current level.

At the end of the refi, you’d be left with the $25,000 “cash out,” minus the transaction costs, including lender fees, settlement, recordation, etc. You could minimize those fees, however, by shopping smart for your refi--with transaction fees as a key negotiating and decision-making tool.

Of course, cash-out refis are not the only game in town. If you don’t care to pull out any of your equity, you can simply go for a rate-cutting refi--locking onto a new fixed-rate mortgage in the low 7% range to replace your current loan that’s above 7.5%.

Homeowners with adjustable-rate mortgages are especially good bets for refis in the current environment. Why stick with a 7.75% adjustable when you can easily switch to a 7.25% percent fixed rate?

Still another factor that could apply to your situation: Both Fannie Mae and Freddie Mac will be financing loans as large as $275,000 after Jan. 1. That means lower rates for 30-year loans that once were considered “jumbos”--too big for purchase by Fannie or Freddie--and were charged higher interest rates as a result.

Advantage May Apply Even to Large Loans

Say you have a $265,000 mortgage that carries a rate that was a half point higher than rates on non-jumbo loans when you originally obtained it. Now, thanks to the new $275,000 Fannie-Freddie limit, you no longer need pay premium jumbo rates. Your loan size--provided it doesn’t exceed $275,000--qualifies for the lowest rates around.

Figure out how much you want to “cash out”--if anything. Go shopping for the best rates and transaction costs. Run the numbers, and be sure you can afford any higher monthly mortgage bills.

Then enjoy what may be an unexpected New Year’s gift: tax-free money at a relatively modest price.

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Distributed by the Washington Post Writers Group.