Cash refinancing for renovations: increase your home equity
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The most popular way to finance home renovations is the cash refinance mortgage. However, a cash-out refinance may not be your best bet. Experts say it only makes sense when:
- You can get a better mortgage rate and / or better terms by refinancing
- The additional costs involved (including closing costs) are less than the cost to finance your renovation in another way
- You will break even on refinancing costs before planning to sell your home
Research your options. Carefully compare the pros and cons and determine how much and how badly you need to finish the renovation.
Check your new rate (Sep 18, 2021)
Do the math
Refinancing cash for the renovation can be a wise choice. Of course, it will depend on your situation. Refinancing could lower your mortgage interest rate. You may also be able to shorten the duration.
Suppose you bought a house for $ 300,000 10 years ago and borrowed $ 240,000. You now have 20 years left on a 30-year mortgage at 6% interest, with a balance of about $ 200,000 and a monthly payment of $ 1,439.
Related: Cash-Out Refinancing Vs Home Equity Loan (Best Deal Might Surprise You)
By refinancing a 15-year mortgage at 4.5% and taking an additional $ 15,000 for home improvements, you would increase your monthly payment by $ 212. But you would shorten your mortgage payment by five years and save over $ 63,000 in mortgage interest over the life of your loan.
That’s more than enough to offset your closing costs, which average around $ 5,000 for a cash refinance of this size.
Alternatively, you can refinance a new 30 year loan at 4.80%. Who would be inferior your new payment of over $ 300 per month while offering you $ 15,000 for renovations. The bad news? You add ten years to your mortgage payment schedule.
The 15-year refinance has a break-even period of just over two years, while it would take you almost four years to recoup your refinancing costs with the 30-year loan.
Weigh the good and the bad
Ralph DiBugnara of Residential Home Funding says that a withdrawal refi has its pros and cons.
“Interest rates are a little higher today than they were just a few years ago. But money is still cheap to borrow. And home values are increasing at a faster rate in 2018, ”he says.
Joshua Harris, clinical assistant professor of real estate at NYU’s Schack Institute of Real Estate, agrees.
“The benefits include getting the lowest cost of borrowing generally available to you,” says Harris. “Plus, you can potentially deduct interest from your taxes. You also have the option of increasing the value of your home by renovating.
The inconvenients ? You will probably pay more monthly. The surcharges for cash-out refinancing apply to the entire loan amount, not just the cash-out.
Related: Home Renovation (Get Your Money’s For Your Money)
“There is also a general risk that the cost of your improvements will be greater than the increased value of the improvements made to your property. This reduces your equity and can decrease your overall wealth, ”adds Harris.
Tap into your capital
Cash refinancing is not the only route you can take to finance a renovation.
Home Equity Line of Credit (HELOC) allows you to borrow against the equity in your home, using your home as collateral. You can withdraw money, up to a pre-approved spending limit, for a set withdrawal period (often the first 10 years) and pay it back over the remaining term of the loan. The costs are low or even zero.
“The interest rate is generally adjustable,” says Matt Hackett, director of operations for Equity Now. “Loan amounts can vary, so it may be possible to finance larger projects if there is enough equity in your home. “
HELOCs are perfect when you need the flexibility for continuous, multi-step remodeling, or when you’re not sure exactly how much you’ll need, or when you don’t need to borrow a large amount.
Related: HELOC vs Home Equity Loan
Here’s an alternative: refinance without withdrawing money, but add a HELOC for your repairs. Rate and term refinances (no withdrawal) are cheaper to do and make sense if you recoup the costs before selling or refinancing again.
Another option is the home equity loan. This loan offers a lump sum at closing and is good when you need a large initial amount. Home equity loans are sometimes referred to as “second mortgages”. Closing costs are higher than a HELOC, but your interest rate is usually fixed, which makes budgeting easier.
Riskier alternatives to cash-out refinancing
Suppose you do not qualify for a Refi Withdrawal Loan, HELOC, or Home Equity Loan. In this case, you can consider:
A personal loan also called a “signature” or “unsecured” loan. With this product, you are not using your home as collateral. Personal loans can be obtained quickly, but have much higher interest rates. Many (but not all) lenders cap personal loan amounts at $ 35,000, and most require excellent credit.
Related: Home Equity vs Personal Loan (Making the Right Choice)
Then there is the credit card borrowing. It is often the fastest and easiest way to finance a renovation. But experts don’t recommend it. “Average rates today are 13% or more. It will cost you almost three times as much as a withdrawal refi or a HELOC, ”says DiBugnara.
However, using a rewards card to fund upgrades and then repaying it with home equity financing could work in your favor.
FHA Rehab Loans
The FHA 203 (k) rehab loan consolidates your refinancing and rehab costs into one loan. And the loan amount (96.5% of the loan-to-value ratio) is based on the improved value of your home, so even if you have little or no equity, you may qualify.
However, one major downside to FHA mortgages is the mortgage insurance required, which amounts to 1.75% up front, plus a monthly premium. And it stays in place for the duration of your loan. Your lender must be approved by the FHA and your renovation costs must be at least $ 5,000.
Related: The FHA 203 (k) Loan, Its Pros and Cons
“For those with limited home equity, a 203 (k) rehab loan may be a great option,” says Christopher Guerin with eLEND. “This loan establishes the value of your home after the improvements are complete. This is different from a traditional refi, which only allows you to access your home equity based on the value of your home before any renovations.
This is a good option if you have less than 20 percent of accumulated equity in your home.
“An FHA consultant will work with your contractor to ensure repair costs are in line with market. In addition, the contractor receives half of the money for the work at the close. They receive the other half at the end of the work. This encourages them to finish on time, ”says DiBugnara.
However, when you have decent equity in your home, you can try cash refinancing with the FHA. It allows a maximum loan-to-value ratio of 80% and is forgiving of credit scores.
When all else fails
There are two other options: pay in cash or defer.
“Your best bet may be to save money and pay cash for your home improvement. This is the option that produces the least risk and the highest overall wealth. But it takes longer and requires patience, ”says Harris.
Or, you could delay the project indefinitely.
“Ask yourself the question: does the renovation add value? Is it worth the cost? Can I finance the improvements while increasing the value of my investment? Your goal should be to recover the financing costs within five years, ”says DiBugnara.
Check your new rate (Sep 18, 2021)