Should I Cash Out Refi To Pay For My Wife’s Student Loans?

For those who weren’t aware, going to medical school can be pretty expensive.  Our current debt load from just under a year and a half of schooling now sits at $65,000.  We’re actually lucky to ‘only owe’ that much too since there are private schools that are much more expensive than the public school my wife attends.  And since I’m working full-time, we don’t need to take out loans for living expenses since my salary and side business income covers that and then some.

Doctor Blues

Becoming a doctor isn’t as lucrative as it once was, seeing as how tuition has steadily increased and pay has steadily decreased, but it is still a good investment (just not a great one).  The government doesn’t seem to think so though since they currently set the rates for unsubsidized and subsidized graduate loans at 6.21% and 7.21%.  Future-doctors suffer because they are lumped in to the same category of loans with lawyers, PHD students, MBA’s, etc and they all get the same interest rate.  That’s great for the M.S.’ers but not such good news for the MD’s since now they are effectively forced to subsidize everyone else’s education.

I don’t know about you but I would much rather ‘invest’ $200,000 in a doctor than a lawyer these days.  But the government doesn’t look at it like that (that’s also one of the reasons why we’re in such a huge student loan bubble that will undoubtedly pop).  They don’t do underwriting, so to them, every grad student has the same amount of risk.  Obviously this is not how things should be done and in case you don’t believe me, just look at what happens when doctors hit the free market.  There are a ton of companies like SoFi or DRBank lining up to refinance their loans at 3-4%.  That is the market rate, not 6.21-7.21%.

What To Do

Even though doctors get the short end of the interest rate stick, that doesn’t mean I’m going to sit there and take it.  One of the options I’ve been exploring is a cash out refi on our former primary residence turned rental property.  If you recall, when we moved up to Newport Beach last year, I decided to rent out my condo instead of selling it.  That is looking like a better and better move each day since the property has appreciated considerably during that time frame and despite a few major expenses at the condo, I’ve managed to make some good money and it’s been a great learning experience on how to landlord (especially from an hour away).

There are a couple of recent sales in my building so it’s pretty easy to estimate the current value and I’d say it’s right around $380,000.  That’s a steep increase since when I bought it in 2010 for $280,000 but sometimes it pays to be lucky.  I still owe $207,000 and have 28 years left on my 30 year loan (7/1 ARM).  So I contacted a friend recently and asked him to help me take a look at what type of rates and amounts I could get by doing a cash out refi.

By the way, if you’re looking for a mortgage consultant, you can contact my friend Chris: chris[at]thebluewatersgroup.com  We have no financial relationship other than he helped me get the quotes for the refi.

Why A Cash Out Refi

The whole point of a cash out refi in this situation would be to pay off my wife’s student loans at a lower rate and save on all of that interest.  My current 7/1 ARM is at 3.125% so I wanted to see what kind of rate I could get and then compare that to the average rate of 6.8% that we’re currently paying on our $65,000 worth of loans.  With a cash out refi, I would also be able to count the added interest in my expense column (you don’t get to deduct the interest but you do get to add it as an expense which is basically the same thing) and offset more of my W2 income.

Crunching The Numbers

I gave my friend the mortgage broker all of my numbers and here’s what he came back with (10/23/2014):

• Option 1: Cash-out up to 75% of your equity with a fixed rate. Assuming a value of $380,000, the new loan amount for a fixed rate could be as high as $285,000 with a rate of 4.25% and an estimated cash out amount of $70,924.98. Closing costs estimated at $2757. Your monthly payment would increase by $472.46 ($929.57 –> $1402.03).
• Option 2: 7/1 ARM, the max loan to value is 65% which would be $247,000 for a value of $380,000. Today, 3.625% is a no points loan. Estimated closing costs would be $2,476. Your estimated cash-out amount would be $33,118.74, and your monthly payment would go up by approximately $200.00 compared to your current payment.

Fixed Mortgage

The fixed mortgage option would be nice because it would only require me to keep 25% equity in the property but there’s a huge interest rate jump from 3.125% to 4.25%.  That would allow me to cash out close to $71,000 though which would be enough to pay off all of our current debt for a savings of $71,000 * (6.8% – 4.25%) = $1,810/year  So that would save me about $151 per month but you also have to consider the $207,000 that I am refi’ing to a higher rate, the closing costs and the delayed payoff date.

The math goes something like this:

My payment would increase by $472.46 but since that would also reset my 30 year payment schedule (I’m 2 years into my current loan), I would need to add an additional $50/mo to get back on track.  So my true cost (ignoring closing costs) would be $522.46 higher per month.  Principal would be about the same so I’d actually be $371 worse off by refi’ing without accounting for the break even point for the closing costs.

I Got Lucky (With My Interest Rate)

Ultimately, my strategy to continuously no cost refi worked out really well.  I started with a 5.25% 30 year fixed in 2010 and no-cost refinanced with Quicken to a 3.75% 7/1 ARM in 2011 when rates went down further.  And then I no cost refi’d again in 2012 with Amerisave when rates went down even further.  I ended up with a 7/1 3.125% ARM which is a pretty insanely low rate for an owner occupied condo in California.  My rate could have been sub 3% if I would have owned a single family home instead of a condo!

You can’t ever time the market but if you no cost refi you can take advantage of further rate drops.  I won’t get the absolute lowest rate possible but I would rather have the ability to take advantage of the dips in the interest rate market which are a lot more likely to happen than me hitting the nail on the head and timing the bottom of the market perfectly.

Other Things That Are Screwing Me

Ultimately the thing that is really costing me is the 208k at 3.125%.  By cashing out, I’ll be saving 3% on $71,000 but I’ll be increasing the payment by 1% on $208,000.  Some other things that aren’t helping either:

• Not Owner Occupied: Since I don’t live there anymore I need 75% LTV for a fixed rate and 65% LTV for an ARM.  Normally, if it’s your primary residence you only need 80% LTV for a cash out refi.
• Can’t Get The Lowest Rates: Since the property is being rented out, I also don’t qualify for the lowest possible rates.  So this costs me even more money.

The ideal situation would be if I was able to take out a second mortgage or a HELOC at a sub 6.8% rate.  That way, I could keep my $207k at 3.125% and not affect the payoff date or the interest amount on the original loan.  Unfortunately, I run into the same problem as I did with the refi’s since the property isn’t owner occupied.

Who Could This Strategy Make Sense For?

There are a lot of people and situations where this might work but ours isn’t one of them.  In order for the numbers to make sense, you need to be refi’ing to an equal or lower rate, live in the property in question and have low closing costs.

Even then though, it might not make sense for a couple of reasons.  The first is a little thing called PSLF or Public Student Loan Forgiveness which basically allows doctors to make the minimum IBR (income based repayment) payments for ten years and then the rest of the debt is forgiven.  The only thing about PSLF is that you have to work at a non-profit or 501(c) type hospital for ten years after you graduate medical school!

Obviously there is a pretty significant income gap between private and these PSLF-eligible hospitals but if you’re doing a long residency and/or fellowship that won’t matter as much and going for PSLF might make sense.

The second thing you have to consider is that you may be able to get a better rate by refi’ing with a bank like SoFi or DRBank.  They are two of the leading banks when it comes to refinancing grad school loans but again if you opt for this you’ll become ineligible for PSLF.

The good thing about owing a lot of money is that there are a lot of options available to help lessen the burden.  Some of them are pretty straightforward but some will require you to think outside of the box.  I like to opt for the latter because that’s generally where you’ll find the best savings.  Obviously, the best solution is to pay off the loans as fast as possible, but in the mean time I’m going to do everything I can to at least minimize the interest portion.

Do you have student loans and have you thought about re-financing them?  Do you see any flaws with this analysis or anything that I’m missing?

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-Harry @ PF Pro