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 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 – if you get a cash-out refi, that will be 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. Now 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.
Why Pay for Renovations with a Refinance?
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.
Other loans that utilize your home’s equity, such as home equity loans or home equity lines of credit (HELOCs) are usually second mortgages. A second mortgage is a mortgage you take out on top of your main mortgage. A cash-out refi isn’t a second loan, but instead replaces your main mortgage.
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.
This is also the case with a personal loan, which is another popular option for homeowners looking for ways to pay for home improvement projects. Personal loans will typically have higher rates than a cash-out refinance. You may also be able to get more cash with a cash-out refi than a personal loan, depending on your home’s worth and how much equity you hold.
The downside of getting a cash-out refi is that you may 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.
You may be able to build back that 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.
What Types of Renovations Can You Use a Cash-Out Refinance For?
When you receive your cash from your cash-out refi, you can use that money 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 diligently. Therefore, it may be worth it to look at what types of projects 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.
Are There Any Downsides?
As we all know, there’s no such thing as free money, and cash-out refinances – like every other type of loan – don’t come without downsides. 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 OK with paying more over the life of the loan?
You should also know that with a cash-out refinance, you’ll have to pay closing costs.
If you’re interested in reviewing your options, you can check out our refinance calculator to see if a cash-out refinance makes sense for you. If you’re ready to begin the process, you can get started online or talk to one of our Home Loan Experts by calling (800) 251-9080. If you still have questions, let us know in the comments below.