The cost of home renovations can add up quickly and you may not be keen on spending your cash reserves on updates throughout your house. As you explore financing options, refinancing your mortgage might be a good move. Real estate prices have been on an upward trajectory for the last several years, resulting in fast equity for homeowners across the country.
Find out how to use a mortgage refinance to pay for your renovations, along with the pros and cons of this financial strategy.
How Does Refinancing Work?
When you refinance your mortgage, you pay off the loan to your original lender and use a new lender with completely new loan terms. Often, this includes a new interest rate (ideally a lower one), a new payment term, and some closing costs.
If you’ve built enough equity in your home, either through previous renovations or market growth, you can also apply for a cash-out refinance. With this option, you borrow more than your original mortgage and receive the difference as cash at closing. The amount of equity you can borrow against varies by lender but most let you take out a mortgage that totals up to 80% of the property value.
Cash-out Refinance Example
Say you bought your home five years ago for $250,000. You made a $10,000 down payment and your mortgage payments have brought down your existing home loan to $200,000. Today, your home is valued at $305,000.
Since most lenders allow for an 80% loan-to-value ratio, you could potentially refinance and get a new mortgage of $244,000. Since your old lender only needs to be repaid the original $200,000 balance, you could then get that $44,000 in cash to use towards a large home renovation process.
Obviously, other factors are considered as part of your refinancing application, including your income, other debts, and credit score. Some lenders may allow you to borrow more than 80% of your home’s value, but this gives you an idea of what to conservatively expect.
Pros and Cons of Renovating with a Cash-out Refinance
Refinancing your mortgage may seem like an easy solution for completing your home projects, and in some cases, it may be. Before moving forward, however, be aware of both the advantages and potential disadvantages of this type of renovation financing.
One of the biggest benefits of using a cash-out refinance to fund home improvements is that interest rates are typically much lower compared to a personal loan or a credit card. Plus, your monthly payments could be more affordable since they’re spread out over a longer term. Personal loan terms usually range from two to five years, while you can refinance your mortgage to any term you’d like (and can afford)—up to 30 years.
Finally, using cash-out funds not only helps to improve your home in a way you get to enjoy, it may also add value to your property.
There are a few financial downsides to be aware of when using a cash-out refinance. For starters, your monthly mortgage payment will be higher than what you’ve been used to since you’re paying a larger loan amount. Plus, while a longer repayment term may feel like you’re spreading out the financial burden, you’re still paying interest for a long time, which can add up over the years.
Another point to consider is whether it’s wise to extend your mortgage. If you’ve already made payments for 5 or 10 years, going back to a 30-year mortgage puts you at an even older age to pay off your house.
Finally, remember that your mortgage uses your home as collateral. While your renovations might add value to the property, that amount is hypothetical until you sell it. If you can’t afford your new monthly payments and fall behind on the refinanced mortgage, you could eventually end up in foreclosure and lose your home. You must be very comfortable with your refinanced amount in order to avoid a heavy financial burden.
How Much Do You Need to Cover a Large Home Project?
Can a cash-out refinance really cover the costs of a large home renovation? Clearly, it depends on your goals for the project. Kitchens are usually the most expensive area of the home to remodel. For minor cosmetic upgrades, like new faucets, lighting, hardware, and paint, expect to spend around $5,000. For a complete overhaul with new cabinets, countertops, and knocked-out walls, the price could go as high as $50,000. A bathroom renovation taken down to the studs could cost between $30,000 to $40,000.1
It’s smart to weigh all of your financing options to find the best way to pay for your home renovations. While a cash-out refinance comes with some risk, you may be comfortable with it if you have a strong financial safety net in place to stay on top of your mortgage payments over time.
1An individual homeowner’s costs might exceed these estimates based on a variety of factors, including location and chosen finishes.