Have you been dreaming of remodeling your kitchen with granite countertops, steel appliances, farmhouse sink, tile, and so on? But is your savings account not up to the task?
You may want to think about doing a cash-out refinance to pay for your home improvements. How does it work?
Well, if the value of your home is more than what you own on your loan, you could be eligible to pull out some equity with a cash-out refinance. This loan replaces your current mortgage with a new, larger loan.
The difference between your old mortgage and the new one (minus closing costs and fees, of course) is yours to spend on your home improvements.
Learn more about why you may want to opt for a cash-out refinance for your home improvements and how to do it.
Why Do Home Improvements With a Cash-Out Refinance?
Using a cash-out refinance to improve your home can be a wise choice – if the project increases the value of your home. For instance, if you spend $25,000 on the kitchen upgrades mentioned above and gain $35,000 in value on your home, we can call that a smart investment.
But remember that not every home improvement project is a good investment. Before you start Googling home improvement contractors with your equity in hand, do some research. Just because you like the home improvement you did does not mean it will increase your home’s value.
A remodeling impact study performed by the National Association of Realtors reports these are the six renovations most likely to increase the value of your home:
- Kitchen renovation
- Kitchen upgrade
- Bathroom renovation
- New roof
- New windows
- New garage door
Why Use a Cash-Out Refinance for Home Improvements?
Most people cannot afford to make a major home improvement with cash. A cash-out refinance can give you the cash you need to make a big improvement in your property that will result in a higher selling price down the road.
A cash-out refinance can be a smart choice for many people because it is replacing the old first mortgage with a new one. This will probably get a better rate than a home equity loan or a home equity line of credit. First mortgages are considered less risky so the rate is almost always lower.
You also may be able to rebuild that equity quickly if you make a smart home improvement that increases your home’s value. Also, you should be able to deduct the cost of the improvement from your taxes in the year you sell the property.
Advantages of A Cash-Out Refinance for Home Improvements
- Big loans: You can probably get tens of thousands of dollars or more, depending on how long you have owned the home and how much its value has increased.
- Low interest rates: Your home secures the loan and it is a first mortgage, so the rates are some of the lowest on the market (first mortgages carry lower rates than seconds because the risk to the lender is lower).
- Possible tax benefits: If you are using the funds for major home renovations, you can probably write off the mortgage interest on the new loan.
- Long period to repay: You will replace your current loan with a 15 or 30-year mortgage that will stretch out the payments.
Disadvantages of A Cash-Out Refinance for Home Improvements
- Interest payments: You are restarting the clock on your mortgage. This boosts your interest costs over your lifetime. Review the amortization tables on your current and proposed loan. If you want to avoid this problem, consider a second mortgage instead.
- Foreclosure risk: You are increasing the amount of money you are borrowing. If you do not repay the loan, the lender will foreclose. A home renovation loan, on the other hand, has a higher rate but is unsecured, so is much less of a risk.
- Closing costs: Any new mortgage has closing costs. Those costs are always paid by you one way or another. You can write a check at closing, take a higher rate, or roll them into the loan balance. To close a new first mortgage, it will probably cost you a few thousand dollars.
Cash-Out Refinance Example
Let’s look at an example. Say you have a 30-year, $200,000 home loan at 6% that you took out six years ago and you pay $1200 per month, with a current balance of $186,000. If your home improvements will cost $10,000, a cash-out refi can be a good option to upgrade your home without straining your budget.
You would take out $10,000 in equity with the refi, for a new mortgage of $196,000 at a new rate of 3.5% for a 25-year term. This would give you a payment of $980. You are paying off your home as scheduled, have an upgraded home and are saving $200 per month. Not a bad deal!
Is Refinancing Better Than a Home Equity Loan?
Maybe. It depends on your circumstances. Refinancing might be a better option than a home equity loan if you intend to stay in your home at least five years, and you can refinance at a lower rate than your current one.
If you plan to move in two years or your rate is already below current rates, you may want to opt for a home equity loan (second mortgage).
But a first mortgage almost always has a lower rate than a second mortgage.
Final Thoughts on Cash-Out Refinance for Home Improvements
Taking out equity with a refinance for home improvements is a great investment if you do a renovation that pays you back, such as a kitchen or bathroom upgrade. If it increases your home’s value, you may end up largely ‘paying yourself back’ with the home improvement. Plus, your family will get years of enjoyment out of your improved home.
Keep in mind that you will need to qualify for the new loan just like you did with your original loan.
Also, most lenders will not lend more than 80% of your home’s value. If your first mortgage interest rate is already low, a home equity loan or line of credit could be a better option. If you have only owned your home a few years, you may not have enough equity to pull cash out.
Speak to a mortgage lender to figure out if you are a better candidate for a cash-0ut refinance or second mortgage to fund your home renovations.
- How To Use a Cash-Out Refinance for Home Improvements. Accessed at https://www.magnifymoney.com/blog/mortgage/how-to-use-a-cash-out-refinance-for-home-improvements/
- 2019 Remodeling Impact Report. Accessed at https://www.nar.realtor/sites/default/files/documents/2019-diy-report-01-03-2019.pdf
- Home Mortgage Interest Deduction. Accessed at https://www.irs.gov/publications/p936
- Cash-Out Refi Is a Great Alternative to a Home Improvement Loan. Accessed at https://www.quickenloans.com/learn/cash-out-refi-a-great-alternative-to-a-home-improvement-loan
- Pros and Cons of Cash-Out Refinancing. Accessed at https://www.thebalance.com/pros-and-cons-of-cash-out-refinancing-4158548