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How to Use a Cash-Out Refinance for Home Improvements

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If you have enough equity in your home, a cash-out refinance for home improvement may give you the extra money you need to increase the value of your home by upgrading your kitchen, finishing a basement or adding a new deck. Knowing the pros and cons of a cash-out refinance will help you determine if it’s your best method for financing home renovations.

Is refinancing your mortgage your best way to finance home improvements?

A home-renovation refinance can be a smart way to fund a renovation project but there are a number of factors to consider. You should use a refinance for home improvement if:

  • You want to roll your closing and renovation costs into one loan
  • You want control over how you use your funds
  • You have more than 20% equity in your home
  • You have a higher mortgage rate than current advertised rates
  • Your credit scores aren’t high enough for a home equity loan or home equity line of credit
  • You’re planning to stay in your home long enough to break even on the costs

Pros and cons of a refinance for home improvement

Pros
  • Your interest rate will be lower than the alternatives. Cash-out refinances are one of the best home improvement loans for lower rates. You’ll likely pay higher rates on personal loans, retail home improvement cards or regular credit cards.
  • Your monthly mortgage payment could go down. If current mortgage rates are much lower than what you’re currently paying, you may end up with a smaller payment even if your loan amount goes up.
  • You may be able to deduct the interest. There may be tax benefits for the mortgage interest you pay.
  • You can spend your home improvement cash as needed. Some home improvement loans, like the FHA 203(k) loan, limit how you spend your renovation dollars. With a cash-out refinance, you have complete control over how you use the money.
  • You’ll qualify more easily if you don’t have good credit. Cash-out refinances may be a better fit if you have bad credit. Credit score guidelines are less stringent and rates are lower than with a home equity loan or home equity line of credit.
Cons
  • You’ll pay more in long-term interest costs. Financing home improvements over 30 years will add thousands in interest charges over the life of your loan.
  • Your monthly payment could go up. Cash-out refinancing for home improvements may result in a larger loan balance because you borrow more than you currently owe to tap the extra equity. Consequently, your monthly payment may go up even if your rates are lower.
  • You’re borrowing against future profits. If you plan to sell your home in the future, tapping more equity now means you might 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 boost your home’s value. However, using a cost versus value estimator may give you an idea of the resale value of improvements in your area.
  • You could lose your home. You use your home as collateral when you get a cash-out refinance mortgage for home improvement. If you can’t make your payments, your lender can foreclose on the home.
  • You’ll pay higher closing costs. Some home renovation loan refinance costs are based on a percentage of your loan amount: The more you borrow, the higher the closing costs. If you opt for a no-cost or low-cost refinance option, lenders increase your interest rate to pay closing costs on your behalf, which results in a higher monthly payment. Expect to pay between 2% to 6% of your loan amount for closing costs.
  • Your rate may be higher than a regular refinance. Home renovation loan rates are typically higher than rates for a regular refinance.

How to qualify for a remodeling cash-out refinance

Cash-out refinance program Maximum loan-to-value ratio (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 and 619)
  • Higher debt load
VA cash-out refinance 90%
  • Higher debt load
  • Eligible military borrowers

Choosing the right type of refinance for home improvement

In order to choose your best cash-out refinance for home improvements, answer these three questions first:

How much will the renovations cost?

Use a remodeling cost calculator to get a rough estimate of how much your project(s) will cost. For more exact numbers, talk to experts at your local home improvement store or meet with a building contractor.

How much equity do you have in your home?

Start with an online value estimator to get an idea of your home’s value. Ask your real estate agent to prepare a comparative market analysis (CMA) for a more educated guess.

What will your new mortgage payment be?

A cash-out refinance calculator is a valuable tool to estimate your new mortgage payment. Input your home’s estimated value, your current loan balance and how much cash you’ll need for renovations. If you can cover the cost of your remodeling expenses without stretching your monthly budget, then a cash-out refinance could make sense.

Alternatives to a cash-out refinance for home improvement

If you don’t have enough equity for a cash-out refinance, consider other types of home improvement loans. And if you don’t like the idea of borrowing against your home, personal loans and home improvement credit cards may be better options.

Home equity loans are a good choice for smaller projects if you want to borrow a lump sum and pay it back with a fixed monthly payment.

Home equity lines of credit (HELOCs) work a lot like a credit card: You receive a certain amount of credit based on your home’s equity, but only pay back the balance you use. In most cases, you can pay off your balance and reuse it as often as you want during the draw period, which usually lasts 10 years. After the draw period ends, you make set payments to pay off the remaining balance.

Home renovation loans include the Fannie Mae HomeStyle® Renovation and the FHA 203(k) renovation refinance. Both of these home improvement loans allow you to roll in your remodeling costs even if you have little to no equity in your home. However, you’ll have less control over how you use your funds since each program requires a contractor and inspector to oversee the project.

Personal loans typically have higher interest rates and shorter repayment periods. You don’t have to use your home as collateral to secure the loan, which means your equity (and your home) are protected.

Home improvement credit cards may offer 0% financing for an introductory time period, like 12 months, which allows you to avoid accruing interest charges as you pay off the renovation balance. They may be the best way to finance home improvements if you plan to pay off less expensive projects quickly.

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

The key to getting your best cash-out refinance rates is to choose the right loan for your renovation project based on your credit and income situation. Here are some tips when shopping for your best home renovation loan rates:

Pick a program that fits your credit and cash needs. Use the table above to match your credit score and borrowing needs to tap the equity you need.

Use a comparison website or call several lenders. Online rate comparison websites help you get multiple quotes relatively quickly, making it easier for you to identify which rates and repayment terms are best for your budget.

Get loan quotes on the same day. Gathering home renovation loan estimates on the same day will ensure you’re comparing apples to apples when looking at rates and fees.

Lock in your interest rate. In most cases, locking your rate means you’ll get the rate the lender initially offered at closing.

 

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