In this article
- Here's What You Need to Know About Using a Refinance to Pay for Your Home Improvements:
- How You Can Pay for Home Improvements by Refinancing Your Mortgage
- Use a Cash-Out Refinance to Fund Major Home Renovations
- How to Qualify to Receive a Cash-Out Refinance
- Advantages and Disadvantages to Refinancing to Pay for Your Home Improvements
- Advantages
- Disadvantages
A cash-out refinance will provide you with a larger, new mortgage that will pay your current home loan off with some extra money as well. One good use of these extra funds can be home improvements.
One of the most popular methods for paying for home improvements is to make use of your home equity by getting a cash-out refinance. When a cash-out refinance is used, you are able to take out more money than what your current mortgage balance is. The difference will then be given to you in the form of cash.
First, your existing mortgage will be paid off. The excess funds can then be used to make upgrades or repairs to increase the value of your home.
Here’s What You Need to Know About Using a Refinance to Pay for Your Home Improvements:
How you can pay for home improvements by refinancing your mortgage:
- Using a cash-out refinance to fund major home renovations
- How to qualify to receive a cash-out refinance
- Advantages and disadvantages to refinancing to pay for your home improvements
- Other methods for paying for home improvements
How You Can Pay for Home Improvements by Refinancing Your Mortgage
A cash-out refinance will provide you with a lump sum payment that can be put towards a large project such as paying for home improvements.
Tip: If you prefer to not commit to using a cash-out refinance, your monthly payment can be lowered through a regular mortgage refinance. That will give your budget some room for gradually paying for smaller improvements.
When you refinance it can also reduce your monthly payments by getting rid of FHA mortgage insurance premiums or private mortgage insurance. The monthly savings could then be put towards home upgrades or repairs.
The following are some examples of some small repairs and upgrades that could be made with some extra money each month:
- Add curb appeal by refreshing your landscaping
- Have ceiling fans installed to reduce energy costs
- Refinish wood floors
- Install energy-efficient window coverings
- Buy new appliances
- Have painters freshen up the interior of your home
For larger projects, you may want to consider a personal loan or a home equity loan.
Use a Cash-Out Refinance to Fund Major Home Renovations
When you get a cash-out refinance, you will receive a larger, new mortgage that will pay your original mortgage off. The remaining funds can then be used for home improvement projects.
Example: You would like to remodel your kitchen. The project is going to cost about $25,000. Say your mortgage balance is $200,000 and your house is worth $325,000. You can apply for a $225,000 cash-out refinance – $200,00 for paying off your current mortgage and $25,000 for the kitchen remodeling project.
Typically, 15% to 20% equity will need to be retained depending on what your lender’s requirements are. This means you could borrow up to 80% to 85% of the value of your home: $260,000 – $276,250.
Borrowing more than $250,000 may be a good idea to cover your new loan’s closing costs and potential extra costs on your kitchen remodel. Once your new loan has closed, $200,000 will be sent by the lender to your current lender for paying off your mortgage and the remaining loan amount will be given to you that can be used for a kitchen remodel.
How to Qualify to Receive a Cash-Out Refinance
You will need to meet the following requirements to get approved to receive a cash-out refinance:
- Have over 15% to 20% home equity. Typically, lenders require that you have 80% to 85% equity remaining after cash is taken out.
- Maintain less than 43% back-end debt-to-income ratio. Your new mortgage payment and other monthly debt payments combined must be at 43% or less of your gross monthly income.
- Maintain a credit score of over 620. Pay all of your debts on time and keep a credit card balance of less than 30% of your credit limit – but it is even better to be at 6% or less.
Advantages and Disadvantages to Refinancing to Pay for Your Home Improvements
Be sure to consider the advantages and disadvantages before you refinance your loan to pay for home improvements.
Advantages
Capitalize on low-interest rates. You may be able to get a lower rate to refinance your mortgage. That will result in lower monthly payments. These savings can then use to pay other debts off.
Make improvements to the value of your property without having to pay out of pocket. It is essential to have several months of living expenses at least in a cash emergency fund. When you choose a cash-out refinance, it allows you to receive money that can be used for your home improvement project without needing to draw on your cash funds.
Use any remaining cash however you want to. There are not any restrictions on how cash-out refinance proceeds can be used. However, a mortgage interest tax deduction can only be claimed for the part that is used for home improvements.
Eliminate private mortgage insurance (PMI). If you refinance your mortgage it can reduce your loan-to-value (LTV) and make it possible to get rid of PMI. If the worth of your home is enough to raise your LTV to 80%, then you will be able to apply to cancel your PMI.
Disadvantages
There will be closing costs that need to be paid. Usually, closing costs are 2% to 5% of the total loan amount or an average of around $5,000. So although you may have a very low-interest rate, having to pay $5,000 in fees for your home improvement loan may not make sense for you unless you are also receiving other benefits from the refinance as well.
Your house is collateral for the loan, which puts you at risk of experiencing a foreclosure. One of the main reasons why a mortgage is one of the least expensive ways to borrow money is because the loan is secured by your home. If you overextend yourself when taking out a cash-out refinance and are unable to keep up with your new monthly payments, you could be at risk of losing your house.
You may have to wait for several days or maybe even weeks for your loan to close. The average refinance in August 2020 took a total of 50 days to close. There are some lenders that are faster than others, and you can help to keep the process moving by quickly responding to all requests.
You may make improvements that do not improve the value of your home. You may really enjoy living in your improved home, however, not all renovations provide a positive return on investment.