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Cash-Out Refinance for Home Improvements

cash out refinance for home improvement

Whether you’re upgrading your kitchen or adding a backyard barbecue deck, home renovations can increase the value and enjoyment of your home. You might consider refinancing your mortgage to pay for these home improvements. If you have enough equity in your home, you can borrow more than what you currently you owe and pocket the difference.

In this guide, we’ll discuss the pros and cons of using a cash-out refinance to remodel your home.

Should you refinance your mortgage to pay for home renovations?

When deciding whether to refinance to pay for home renovations, there are three questions to ask yourself:

  1. How much will the renovations cost? Determine a realistic estimate for the cost of your home renovations. A remodeling calculator can help you come up with a rough estimate. For more exact numbers, talk to experts at your local home improvement store or meet with a building contractor.
  2. How much equity do you have in your home? Use an online home value estimator to get an idea of your home’s value. Ask your real estate agent to prepare a comparative market analysis (CMA) to learn what similar homes nearby have sold for recently.
  3. What will your new mortgage payment be? Estimate your new mortgage payment with a cash-out refinance calculator. Input your home’s estimated value, your current loan balance and how much cash you’ll take out.If you have enough equity to take out the cash you need to pay for remodeling expenses and the new mortgage payment won’t stretch your monthly budget, then a cash-out refinance makes sense.

The pros and cons of refinancing to remodel

Even if you have enough equity in your home to borrow extra funds in a refinance, doing so still comes with its advantages and disadvantages.

Pros

  • You’ll have access to lower interest rates than the alternatives. Cash-out refinance rates are typically lower than interest rates on personal loans, retail home improvement credit cards or regular credit cards.
  • Your monthly mortgage payment could go down. If current mortgage rates are much lower than what you’re paying on your current loan, you may end up with a lower monthly mortgage payment.
  • You may be able to deduct the interest. There may be tax benefits to the extra mortgage interest paid for home improvements. Keep your receipts and invoices — you’ll need them to get the write-off.
  • You control how your home improvement cash is spent. Some home improvement mortgages, like the FHA 203(k) loan, require you to make decisions with an inspector and your contractor. In a cash-out refinance, the money is yours to use as you want.
  • You won’t have extra payments to manage. Because the cost of your home improvements will be rolled into your mortgage, you will only have to keep track of one monthly payment.
  • You’re more likely to qualify if you don’t have good credit. Cash-out refinance programs allow for lower credit scores at better rates than you’ll find with a home equity loan or a home equity line of credit.

Cons

Borrowing more money with a cash-out refinance increases the long-term interest cost. There are also some drawbacks to tying up your equity to finance home improvements.

  • Your monthly payment could go up. Even if current rates are low, a bigger loan balance could result in a higher monthly payment. Cash-out refinancing for home improvements typically results in a larger loan balance than your original mortgage because you’re taking out more of the equity.
  • You’re borrowing against future profit. If you plan to sell in the near future, borrowing more of your equity now means you’ll make less at the closing table later.
  • Your home’s value may not go up. There’s no guarantee you’ll recoup home improvement costs or that the renovations will increase your home’s value. Using a cost versus value guide could help you decide which improvements have the most resale value in your area.
  • You could lose your home. If you’re thinking about cash-out refinancing for home improvements, you’ll want to be careful. Mortgages are backed by your home, and if you can’t make payments because of a higher monthly payment, the lender has the right to foreclose.
  • You’ll pay higher closing costs. Some mortgage costs are based on a percentage of your loan amount, and the more you borrow, the higher the closing costs. Lenders offering no cost or low-cost refinance options simply increase your interest rate to pay for closing costs, which will result in a higher monthly payment. Expect to pay between 2% to 6% of your loan amount for closing costs, depending on the loan amount.

How to qualify for a cash-out refinance

Choosing the best cash-out refinance program depends on your credit scores and how much equity you need to borrow. Government loan programs like the FHA cash-out refinance are easier to qualify for with low credit scores. For homeowners with higher credit scores, a conventional loan is often the best choice. Eligible veterans and active-duty military borrowers can access more of their home’s equity with a VA cash-out refinance than through FHA and conventional cash-out loans.

The table below shows the most popular cash-out programs, how much of your home’s value you can borrow (a measure called your loan-to-value ratio or LTV) and who these programs are right for.

Cash-out refinance program Maximum LTV Best cash-out option for:
Conventional cash-out refinance 80%
  • Good credit (620+)
  • Moderate debt load
FHA cash-out refinance 80%
  • Bad credit (between 500-619)
  • Higher debt load
VA cash-out refinance 100% until November 2019

90% after November 2019

  • Bad credit (no minimum, but 620 is recommended)
  • Higher debt
  • Eligible active duty or veteran military personnel

Alternatives to a cash-out refinancing for home improvements

Cash-out refinancing isn’t the only option for financing your home improvements. If you don’t have enough equity for a cash-out refinance, home renovation loans may be a better choice. There are also home improvement financing choices, such as personal loans and home improvement credit cards, that don’t require a loan on your home.

  • Home equity loans and home equity lines of credit (HELOC) are a good choice to pay for smaller projects or if you want to keep your current mortgage because it has a low interest rate. With a home equity loan, you borrow a lump sum and pay it back with a monthly fixed payment. A HELOC is a line of credit that works a lot like a credit card: You’re extended a certain amount of credit based on your home’s equity, but you only pay interest based on the balance you use. You can pay the balance off and charge it as often as you wish during the draw period. After the draw period ends, you pay the remaining balance off on a set repayment schedule.
  • Home renovation mortgages like Fannie Mae’s HomeStyle® Renovation Mortgage or the FHA 203(k) renovation refinance allow you to refinance to remodel even if you don’t have a lot of equity in your home. However, you must share control of how the mortgage funds are spent with a contractor and an inspector who will oversee the project.
  • Personal loans offer short-term financing — typically at higher interest rates — that you pay off over a shorter period of time. Such loans are not secured by your home, so your equity is protected.
  • Home improvement credit cards may offer 0% financing for specific time period, like 12 months, which allows you to pay off a renovation over time without accruing interest charges. For smaller home project expenses you plan to pay off quickly, home improvement credit cards can be beneficial.

Tips for getting the best deal on a cash-out refinance

The key to getting the best cash-out refinance is to choose the loan that gets you the money you need based on your credit and income situation. Here are some tips for shopping for a cash-out refinance lender.

Pick the program that suits your credit and cash needs. Check the table above to make sure you’re picking a cash-out refinance program that matches your credit scores and gives you enough borrowing power to access the cash you need.

Use a comparison website or call several lenders. Online rate comparison websites make it easy to shop multiple lenders. Input your home’s estimated value, the program you’re looking for and answer a few questions about the property your refinancing. Lenders will call you with offers. You can also call or email several lenders yourself to find the best rate.

Get loan quotes on the same day. Interest rates can change daily and gathering loan estimates on the same day will ensure that you’re comparing apples to apples mortgage rate and cost quotes. 

Lock in your rate. Most loan officers lock in your rate once you’ve chosen the rate and terms that are a good fit for you. Ask for a mortgage rate lock confirmation by email or fax if you don’t receive it within a couple of days of completing your loan application.

 

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