Home renovations and maintenance can get expensive. A cash-out refinance offers an option to pay for these projects that doesn’t involve getting a second mortgage or the typically higher interest rates of a home equity loan, HELOC, or personal loan.
If you’re considering a cash-out refinance to help pay for any home improvement projects you want to tackle, here’s what you need to know.
What Is A Cash-Out Refinance?
First, let’s go over what a cash-out refinance is.
A cash-out refi allows you to utilize the equity you have in your home to get a new, refinanced mortgage to replace your existing mortgage, while converting some of that equity into cash.
Essentially, you’re borrowing more than you currently owe on your loan and pocketing the difference. To do this, you have to already have equity in your home.
Cash-out refinances are different from second mortgages. When you get a cash-out refi, that becomes your primary mortgage.
For example, if you bought your home 10 years ago for $200,000 and have paid off $75,000 of the loan, you’d still owe $125,000. Let’s say home prices are on the rise, and your home is now worth double. If you got a cash-out refinance for $250,000, you’d pay off the outstanding $125,000 balance and then take the remaining $125,000 for a remodel or renovations.
When considering your eligibility for a cash-out refinance, lenders will consider factors such as your credit score, the amount of equity you have in your home, and your debt-to-income ratio (DTI).
Can You Use A Cash-Out Refinance For Any Home Improvement?
Unlike most home improvement loans, a cash-out refinance allows you to use the money you get however you choose. However, keep in mind that this is money that you’ve earned over many months and years of making payments on your home, and you should use it wisely. Therefore, it may be worth it to look at what types of home improvements and renovations are most likely to increase your home’s value.
If your home’s main systems or components are in need of an update, take care of those first before deciding on whether your kitchen would benefit from a remodel. If you end up selling your home down the road, upgrades to its major components can be highly attractive to potential buyers. Not only that, but certain improvements – such as replacing the roof or HVAC systems – may get you discounts on your homeowners insurance premium.
Should You Refinance For Home Improvements?
If you have a big cost you won’t be able to cover using your savings, a cash-out refinance allows you to tap into what is likely your most valuable asset – your home. Since home improvement projects can often be quite costly, a cash-out refi can make them affordable for you.
But should you do it? Let’s take a look at the pros and cons.
Pros Of Refinancing For Home Improvement
Because a cash-out refi is your primary loan, you’ll generally be able to get a better rate than you would with a home equity loan or HELOC, which are usually second mortgages you take out on top of your main mortgage.
Cash-out refis also have advantages over personal loans, which typically have higher rates. You may also be able to get more cash with a cash-out refi than a personal loan, depending on your home’s value and how much equity you hold.
Of course, there’s always a possibility you could end up with a higher rate than what you’re currently paying. However, if current mortgage rates are lower than when you purchased your home, you may be able to snag a lower rate.
Another advantage of refinancing for home improvement is that you may be able to build back equity relatively quickly if the renovation you’re doing increases your home’s value. Plus, depending on what type of improvement project you do and how much your house sells for, you may be able to deduct the cost of the improvement from your taxes in the year you sell.
Cons Of Refinancing For Home Improvement
As we all know, there’s no such thing as free money, and cash-out refinances – like every other type of loan – come with downsides for borrowers. Whether it’s worth it to get one is going to depend on your individual situation.
Before you decide on taking out any kind of loan, take some time to calculate the cost of the project you want completed. Call contractors and get estimates on the work that will need to be done. You want to know exactly how much it’s going to cost and where the money will go, so you know how much you need and don’t end up borrowing too much (or too little).
Figure out how much changing your mortgage would affect your finances. If your monthly payment goes up, will you be able to afford that? If your rate increases, are you willing to pay more interest over the life of the loan?
You should also know that with a cash-out refinance, you’ll have to pay closing costs.