The typical homeowner gained approximately $5,300 in equity last year. In more expensive states, many gained more than $20,000 in personal equity. If you are thinking about building a new home, you may be able to do a cash-out refinance on your existing home to pay for the new one.
Many homeowners choose to make the down payment on new home construction with a cash-out refinance. Or, if you have a lot of equity, you might even be able to pay for the new property with all cash.
Learn more below about your options to build a new home with a cash-out refinance.
Overview of a Cash-Out Refinance
One way to pay for new home construction is to pull out equity in your current residence. You might be able to take out up to 80% of your equity (minus what you owe) and use those funds for your new home construction. Bonus – you might be able to refinance to a lower rate simultaneously.
Here are some important factors to consider before you do this:
- Your ability to do a cash-out refinance depends on how much equity you have, the value of your home, and your credit score.
- If you are interested in buying and then selling or refinancing one of the properties, a bridge loan could be for you.
- A home equity loan or home equity line of credit (HELOC) may be the best way to get the money quickly.
- If you do not have enough equity to pay for the entire home or down payment, you may also consider a personal loan.
How Much Equity Do You Have for New Home Construction?
On first glance, you might think the equity matter is easy. Say you bought your house for $150,000 and the current appraisal is for $275,000. You have equity of $190,000.
So you can apply for a refinance with cash out and get $190,000?
Most mortgage lenders allow a cash-out up to 80% of your available equity, based on the most recent appraisal. Your lender will see a home value of $275,000, subtract $55,000 (20%). That leaves you with $220,000. This sum is used to pay the current loan – $85,000.
The balance of $135,000 is available to you to pull out for new home construction.
Some lenders may let you take out more. For example, a VA cash-out mortgage lets a qualified borrower refinance 100% of their home equity. Some FHA cash-out refis will allow up to 85%. But these programs are saddled with charges and mortgage insurance costs. You might be best off without those.
Rules of a Cash-Out Refinance
One of the best ways to use your equity is to buy a new home. But it is important to stay in your home for a while if you want to use the money for new home construction.
With most refinances, it is required to stay in your current home for at least a year. If you violate the rules, the lender can call the loan and demand repayment.
However, lenders have different rules, so check with a few loan professionals on this important matter.
Also, if you are building a new home, it may not be ready for you to move in for a year anyway.
Other Options to Pay for New Home Construction
You can use a HELOC or home equity line of credit for new home construction. This could be the way to go if you are happy with the interest rate on your first mortgage. But there are some downsides to a HELOC:
- The interest rate is almost always adjustable after an introductory period of six months to a year.
- Second, the interest rate is higher than on a first mortgage. How much higher? It depends on your credit score, the amount you want, equity, and part of the country.
- You also need to watch the balance of your credit line to avoid expensive fees.
Another option is a bridge loan. This mortgage is designed to help you pull equity from one property and put it into new construction or another home.
A benefit of a bridge loan is it is short-term financing. The only may only be for a few months. No monthly payments are required.
But you will have a high-interest rate, up to 2% more than a typical first mortgage. You might get hit with thousands in up-front fees, too. A bridge loan can do the job though if you want to build a new home. When you sell your current house, the bridge loan is paid off at the closing table.
Final Thoughts On Cash-Out Refinance for New Home Construction
Refinancing your mortgage with cash out can be a great way to get the money you need to fund new home construction. You can possibly get a lot of cash at a low-interest rate, depending on your home’s value, equity, and credit score.
But there are time limits on moving to a new property with cash pulled out from your current residence. Talk to an experienced mortgage lender today to figure out if a cash-out refinance is a viable option to fund your new home construction.
- Home Equity Report. Accessed at https://www.corelogic.com/insights-download/homeowner-equity-report.aspx
- How to Use a Cash-Out Refinance to Buy Another Home. Accessed at https://themortgagereports.com/41146/how-to-use-a-cash-out-refinance-to-buy-another-home
- Cash-Out Refinancing. Accessed at https://www.credible.com/blog/mortgages/cash-out-refinancing/