With interest rates sitting at a historical low & home equity at an all time high , now’s the time to refinance for home improvement. Home projects can boost your property’s value, enhance your lifestyle, and fix necessary safety issues.
But, before you start tearing down walls and ripping up floors, you need a plan. How will you finance the renovations? How much is in your budget? Will you get the best bang for your buck?
We’ll cover everything you need to know before pulling the trigger on refinancing for your home makeover. But first, let’s define what refinancing is and how it works.
Refinancing a mortgage means trading in the loan you originally took out for a new one. Your new loan will come with different terms, such as a lower interest rate and a longer or shorter repayment period.
One of the most popular ways for homeowners to refinance and renovate is a cash-out refinance.
What’s a cash-out refi?
A cash-out refi swaps out your current mortgage loan with a larger loan and lets you pocket the difference in cash. This cash is converted from your home’s equity. So, the more equity you’ve accumulated, the more money you’ll be able to convert to cash.
Let’s look at an example of a cash-out refinance for home improvement to give you a clearer picture.
How it works
Alright, say you currently owe $170,000 on your mortgage, but the market values your home at $290,000. You would have a difference of $120,000 in equity.
$290,000 - $170,000 = $120,000
If you wanted to do a cash-out refinance for remodeling your home, you’d start browsing lenders to see who could give you the best terms. Let’s say you find a lender who's willing to loan you 80% of your home’s value. This would leave you with $232,000.
290,000 x .80 = $232,000
Now, you’d still have to pay off the remaining principal of $170,000. But, you’d be left with $62,000 in cash to renovate your kitchen, bathroom, porch…whatever you want!
$232,000 - $170,000 = $62,000
In this example, you had $120,000 in equity before you applied for the cash-out refi. Let’s go over the equity requirements for taking cash out.
How much equity do I need to have?
To do a cash-out refinance for home improvement, you need to have built up a certain amount of equity. Most lenders will require you to have at least 15 to 20% equity to take cash out with a refi loan.
In our above example, you had 41% equity in your home ($120,000 / $290,000 = 41%). This amount would make it easy to qualify for a cash-out refi. But, you'd need to meet the lender’s other qualifications as well, like having a good credit score and a low DTI.
So, say you meet all the requirements to refinance your mortgage. Does that make it worth it for financing a home remodel?
Let’s take a closer look.
Is refinancing for home improvement worth it?
Not every single home project justifies a cash-out refi. A cash-out refi is a big commitment. Thus, it may not be a wise option if you’re only going to use the money to buy a new TV or add a built-in shelving unit.
This is why the pros and cons are important to know when refinancing a home. So, let’s explore the different benefits and drawbacks to help you make a decision that’s best for your scenario.
Pros of a cash-out refinance for home improvement
There are many upsides to a cash-out refi. We’ve made a rundown of the top four that homeowners like to take advantage of.
Home renovation at a low-cost
Renovation financing is a costly investment that can make a remodel seem intimidating. But, with a cash-out refi, the costs of your home projects are wrapped into the new loan you take out. As a result, it’s a great way to borrow a lump sum of money at once without compromising your monthly budget.
If your renovations increase your home’s value, you can deduct the interest from your taxes. Here are a few home projects that typically meet IRS eligibility requirements for an interest deduction.
- Adding a hot tub or pool
- Adding a new bathroom or bedroom
- Updating your roof or windows to improve durability and weather resistance
- Remodeling kitchens or updating kitchen appliances
In our current housing market, mortgage interest rates fall close to 4%. Although rates are higher than they were at the start of this year, they’re still sitting at a historical low.
What this means for homeowners who want to refinance for home improvement is that they'll likely get a lower interest rate.
Boost your home’s value
It’s no secret that home improvements have an expensive reputation. But, they’re completely worth it when they end up boosting the value of your home. When it comes time to sell, homeowners recoup an average of 74 cents for every dollar spent on renovating.
While a kitchen remodel can get you around 50% back of what you spent, new hardwood floors can recoup up to 106%.
Before starting your project, research home upgrades that have the largest appeal. This will ensure you recoup the cost of your investment when you sell.
These pros make homeowners excited to jumpstart their home reno. But, there are a couple of cons to think about when considering a cash-out refi as well.
Cons of a cash-out refinance for home improvement
The two primary drawbacks of a cash-out refi are the costs and the commitment.
It costs money
A cash-out refi isn’t free. The cost of refinancing includes an appraisal, taxes, origination fees, and any other closing costs. To give an idea of how much it costs to refinance, homeowners paid an average refi closing cost of $2,398 in 2021.
It’s a long-term commitment
A cash-out refi typically lengthens the term of your loan. This means that it’ll take longer for you to pay it off. So, while an extended repayment term spreads out the financial burden, the interest adds up.
So, how do I know if a cash-out refinance for renovations is for me?
You’ve looked at the pros and cons of refinancing for home improvement– now what? Let’s go over a few example scenarios for when it’s a good idea, and when it may not be one.
When it’s a good idea
Refinancing your home for remodeling can be a smart move when you can get a lower interest rate and drive up your property’s value. Likewise, it's a good idea if you have a lot of equity and need a substantial amount of money for renovations.
When it’s not a good idea
Just like your original mortgage, your refi loan will use your home as collateral. This said, if you're not sure if you'll be able to afford your new monthly payments, it may not be wise to refinance.
Also, you should think about how big of a home improvement you'd like to do. If the renovations are relatively cheap, you may want to finance them in a way that doesn't put your home at risk of foreclosure.
Other ways to finance a home renovation
While refinancing for home improvement can be a smart option, it isn’t your only option. You can also use your savings or take out other types of loans to pay for your home makeover.
The best way to pay for home improvements will always be what works for your situation. But, using your savings is the safest option. This is because it doesn’t involve interest, additional fees, or a repayment contract.
Also, if you use your savings as a home renovation fund, it confirms you can afford the costs of renovating.
Home improvement loan
A home improvement or home repair loan is an unsecured personal loan. Since this type of loan is unsecured, it doesn’t require your house to be used as collateral. A home repair loan is a good choice if you don’t want to use your home to secure the loan or if you haven’t accrued any equity.
Home equity loan
A home equity loan is a second mortgage that puts your home up as collateral. The total amount of the loan is borrowed up front, and repayments begin immediately. With home equity loans, you can generally borrow up to 85% of your equity with fixed interest.
Want help on your home improvement plan?
Still wondering if refinancing for home improvement is right for you? Talk to one of our mortgage experts today for a consultation. We’ll help you find the best option for your situation.