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Low mortgage rates are tempting an increasing number of homeowners to turn equity into cash. And among the options -- home equity loans and home equity lines of credit -- cash-out refinancing is growing in popularity.

But taking the extra money now could likely result in a higher bill later.

With the cash, you might have to buy "a brand-new shovel to dig yourself a hole with," warns Keith Gumbinger, a vice president with mortgage tracker HSH Associates.

Nevertheless, with mortgage rates currently below 7% and near historical lows, many homeowners can't resist the option. Indeed, in the third quarter of 2001, cash-out refinancing increased to 63% of the total number of mortgage refinances, up from 58% in the second quarter and 50% in the first, according to the most recent information from

Freddie Mac


, the federally chartered mortgage lender.

With cash-out refinancing, you refinance your mortgage for more than you owe, and keep the difference. The amount that you add to your original mortgage has to be 5% or more of your home's equity. Say you owe $100,000 on a house that cost $150,000. You can refinance for $120,000 and pocket the extra $20,000, while also obtaining a lower interest rate on your loan.

Sure, the extra cash to pay off credit card debt or remodel a kitchen might be attractive. But with cash-out refinancing, you must start your mortgage over as if you hadn't yet paid a dime. As a result, you are further away from paying down your principal, and though the monthly bills shrink because of your new lower interest rate, the payments on that interest can add up over time.

If you do a cash-out refinance, "you are restarting from scratch, and you will be paying back far in excess from what you were starting out with," says Gumbinger.

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Take, for example, a homeowner who has a 30-year mortgage for $100,000 at a fixed rate of 7% and pays $665 a month. After seven years, the homeowner will have paid about $8,000 on the principal.

If the homeowner does a cash-out refinancing for the amount paid on the principal, about $8,000, by taking a new 30-year mortgage for $100,000 at a fixed-rate of 6.75%, the monthly payments decrease by $17. "But the total cost of your mortgage over 37 years is $180,528 in interest," Gumbinger says, noting the original cost of the loan: $139,508.95.

Another downside to cash-out refinancing: You have to pay closing expenses again. Remember, the smaller the drop in interest rate on your new loan, the longer it will take you to recover the cost of refinancing.

Also consider the ways you plan to spend the extra money. If it's a solid investment that appreciates or adds value, such as investing in real estate or remodeling the home, then cash-out refinancing can be a good source of tax-deductible capital at a low rate, says Eric Tyson, author of

Personal Finance for Dummies


But Tyson warns that cash-out refinancing could encourage rampant spending. "People who do them have traded one debt for another," he says.

While it may seem like a good idea to receive capital at a low rate, there's no telling what could happen down the road. "If you run into financial difficulty, you put your house at risk," says Rick Bloom, a certified financial planner with Bloom Asset Management in Farmington Hills, Mich.

Bloom adds, however, that cash-out refinancing is excellent for people who meet their financial goals. To avoid additional costs, Bloom recommends looking into credit unions, which tend to offer no-point, no-cost refinancing.