Should You Refinance to Pay for Home Improvements?

One popular way to pay for home improvement projects is to utilize your home equity through a cash-out refinance. With a cash-out refinance, you take out more than your current mortgage balance and receive the difference in cash.

First, you’ll pay off your existing mortgage, and then you can use the excess funds to make repairs or upgrades that increase your home’s value.

How refinancing your mortgage can pay for your home improvement

A cash-out refinance can pay for home improvements by giving you a lump sum payment, which you can put toward a big project.

Tip: If you don’t want to commit to a cash-out refinance, a regular mortgage refinance can lower your monthly payment, which might make room in your budget to gradually pay for smaller improvements.

Refinancing could also lower your monthly payment by eliminating your private mortgage insurance or FHA mortgage insurance premiums. Again, you could put the monthly savings toward home repairs or upgrades.

Here are a few examples of small fixes that you could make with a little extra money in your pocket every month:

• Hire painters to spruce up your home’s interior
• Get new appliances
• Add energy-efficient window coverings
• Refinish wood floors
• Install ceiling fans to lower energy costs
• Refresh landscaping to add curb appeal

For bigger projects, you might want to also consider a home equity loan or personal loan.

Funding major home renovations with a cash-out refinance

When you do a cash-out refinance, you get a new, larger mortgage that pays off your original mortgage, and you can use the remaining funds for your home improvement project.

Example: You want to remodel your kitchen. The job will cost around $25,000. Let’s say you have a mortgage balance of $200,000, and your home has a value of $325,000. You could apply for a cash-out refinance for $225,000 — $25,000 for your kitchen and $200,000 to pay off your existing mortgage.

You’ll typically have to retain 15% to 20% equity, depending on the lender’s requirements. That means you could borrow as much as 80% to 85% of your home’s value: $260,000 to $276,250.

It might be smart to borrow more than $25,000 to cover the closing costs on your new loan and possible cost overruns on the kitchen remodel as well. When your new loan closes, the lender will send $200,000 to your current lender to pay off your mortgage and give you the remaining loan amount to use for your kitchen remodel.

How to qualify for a cash-out refinance

To get approved for a cash-out refinance, you’ll need to meet these qualifications:

• Have more than 15% to 20% equity in your home. Lenders typically require you to have 80% to 85% equity left after you take cash out.
• Maintain a back-end debt-to-income ratio of less than 43%. Your other monthly debt payments plus your new mortgage payment should add up to no more than 43% of your gross monthly income.
• Keep your credit score above 620. Pay your debts on time and don’t carry a credit card balance of more than 30% of your credit limit — but 6% or less is even better.

Find Out: Capital Improvements: Your Guide to Tax-Deductible Renovations

Pros and cons of refinancing for home improvements

Before refinancing your loan for home improvements, make sure you consider the pros and cons.

Pros

• Take advantage of low interest rates. You might be able to refinance your mortgage at a lower rate, which can lead to lower monthly payments. You could then use these savings to pay down other debt.
• Improve your property value without paying out of pocket. It’s important to always have at least several months’ worth of living expenses in a cash emergency fund. By opting for a cash-out refinance, you can get money for home improvement projects without having to dip into any cash funds.
• Use leftover cash for whatever you like. There are no restrictions on how you use the proceeds from a cash-out refinance. You can only claim a mortgage interest tax deduction for the part you put toward home improvements, however.
• Get rid of private mortgage insurance (PMI). Refinancing your mortgage may lower your loan-to-value (LTV) ratio and allow you to eliminate PMI. If your home is worth enough to bring your LTV to 80%, you can apply to have your PMI canceled.

Cons

• You’ll have to pay closing costs. Closing costs generally amount to 2% to 5% of the loan amount, averaging out to $5,000. Even though the interest rate might be incredibly low, paying $5,000 in fees for a home improvement loan might not make sense unless you’re getting other benefits from refinancing, too.
• Your home is collateral, putting you at risk of foreclosure. The reason a mortgage is one of the cheapest ways to borrow money is that your home secures the loan. If you overextend yourself with a cash-out refi and can’t keep up with the new payments, you risk losing your home.
• You might spend several days — even weeks — waiting for the loan to close. In August 2020, the average refinance took 50 days to close. Some lenders are faster than others, though, and you can help move the process along by responding to all their requests rapidly.
• The improvements you make might not improve your home’s value. They might improve how much you enjoy living in your home, but not every renovation will provide a return on your investment.

Other ways to pay for your home improvements

Other sources of home improvement funding might appeal to you more because they might be faster, easier, or cheaper to obtain.

Personal loan

A personal loan lets you borrow a lump sum at a fixed interest rate and repay it over a set number of years. It can be a good choice when you don’t want to use your home as collateral for the loan or when you want to get the money quickly.

Home equity loan

A home equity loan might be right for you if you want to borrow a lump sum but won’t benefit from refinancing. Because it’s a second mortgage, the interest rate will be higher than what you’d pay on your existing mortgage, but you’ll also be borrowing a smaller amount. The smaller loan will keep your closing costs and total interest charges down.

HELOC

A home equity line of credit can be a good choice if you’re doing a series of smaller home improvement projects that you don’t need to pay for all at once. It’s also a second mortgage, so your home will serve as collateral. It will have a variable interest rate, so you’ll need to plan for fluctuations in monthly payments.

Credit card

Your favorite home improvement store might offer a credit card with 0% financing for six to 24 months, depending on how much you spend or what type of project you’re doing. Getting approved for a new credit card is faster and easier than getting approved for a mortgage and comes with no closing costs.

If you can pay off all your charges during the 0% introductory period, a home improvement credit card — or any 0% APR credit card — might end up being the easiest and cheapest way to pay for home improvements. However, if you don’t fully repay what you charged during the promotional period, the interest can be higher than a mortgage or personal loan.

Keep Reading: Personal Loan vs. Credit Card

Which type of loan is best to pay for home improvements?

Certain loan types are more fitting for certain situations. Here are the loan types you should consider, depending on your financial situation:

Credible is a good choice for comparing several of these options, including cash-out refinances, personal loans, and credit cards.

If you’re considering a cash-out refinance, be sure to consider as many lenders as possible. Credible makes finding the best deal easy — you can compare multiple lenders and see prequalified rates in as little as three minutes.