Homeowners often dream of updating their living spaces, but the cost of renovations can be daunting. If you’re looking to make some home improvements without depleting your savings, refinancing your mortgage might be an option. In this guide, we’ll explore the ins and outs of using refinancing to pay for renovations to help you decide if this strategy is the right move for you.
What Is Cash-Out Refinancing?
Cash-out refinancing is a popular way to fund home renovations. It involves replacing your existing mortgage with a new, larger loan. The difference between your new loan amount and your current mortgage balance is given to you in cash, which you can use for various purposes, including home improvements. This option is available to homeowners who have built up a decent amount of equity in their property, either through market appreciation or by paying down their mortgage over time.
How Cash-Out Refinancing Works
Imagine you bought your home five years ago for $250,000. You made a $10,000 down payment, and through regular mortgage payments, you’ve reduced your loan balance to $200,000. Today, your home is valued at $305,000.
Most lenders allow for an 80% loan-to-value ratio, meaning you could potentially refinance and get a new mortgage of $244,000 (80% of $305,000). Once your old lender is paid the original $200,000 balance, you could receive the difference of $44,000 in cash to use toward your renovation projects.
It’s important to note that lenders weigh many factors when approving a cash-out refinance, including your income, credit score, and overall debt load. Some lenders may allow you to borrow more than 80% of your home’s value, but this example provides a conservative estimate of what you might expect.
Pros of Using Refinancing for Home Renovations
Let’s explore some of the key benefits of refinancing to fund home renovations.
Lower Interest Rates
One of the biggest advantages of cash-out refinancing is the potential for lower interest rates compared to other financing options. Mortgage rates are typically lower than those for personal loans or credit cards, which can result in significant savings over time. This is especially beneficial if you’re planning extensive renovations that require a large amount of money.
Potential Tax Benefits
Another advantage of using a cash-out refinance for home improvements is the potential tax benefits. While you should always consult a tax professional for advice specific to your situation, the interest paid on mortgage debt used for home improvements may be tax-deductible. This could lead to additional savings come tax season, making your renovation project more affordable in the long run.
Increased Home Value
Using refinanced funds for home improvements can also increase your property’s value. Strategic renovations in certain areas of your house, such as kitchen or bathroom updates, can boost your home’s overall worth. This increased value not only benefits you if you decide to sell in the future, but can also provide additional equity.
Cons of Refinancing to Fund Home Projects
While refinancing to pay for renovations has advantages, it’s important to consider the potential drawbacks before making a decision.
Higher Monthly Payments
One of the biggest disadvantages of cash-out refinancing is that your monthly mortgage payments will likely increase. Since you’re borrowing a larger amount, you’ll be responsible for repaying not just your original mortgage balance but also the additional funds you’ve taken out. This increased financial obligation can strain your monthly budget, so be sure you can comfortably afford the new payments before proceeding.
Extended Mortgage Terms
If you’ve already been making payments for several years, refinancing might reset your loan term to 15–30 years. While this can make monthly payments more manageable, it also means you’ll be paying interest for a longer period of time, potentially increasing the overall cost of your loan. Consider whether you’re comfortable with the idea of extending your mortgage timeline, especially if you’re nearing retirement age.
Risks of Using Your Home as Collateral
The most significant risk of cash-out refinancing is that your home serves as collateral for the loan. While your renovations might add value to the property, that amount is hypothetical until you sell. If you struggle to keep up with the new, higher monthly payments, you could risk foreclosure and potentially lose your home. Make sure you’re confident in your ability to manage the refinanced amount to avoid this heavy financial burden.
Can Refinancing Cover Your Renovation?
Before deciding to refinance, calculate your renovation costs. Different projects have varying price tags, and knowing these costs can help you determine if refinancing will provide sufficient funds for your plans.
Estimating Kitchen Remodel Costs
Kitchen renovations often top the list of desired home improvements, but they can be among the most expensive. According to Angi.com, the cost of a kitchen remodel varies depending on the scope of the project:
- Minor cosmetic upgrades (new faucets, cabinets, flooring, lighting, hardware, and paint): $10,000–$20,000
- Major remodel (new countertops, cabinet refacing, updated appliances, assing an island): $20,000–$65,000
- Major overhaul (custom cabinetry, luxury countertops, electrical re-writing, new cabinets, high-end appliances, layout changes): $65,000–$130,000+
When planning your kitchen renovation, consider which elements are most important to you and allocate your budget accordingly. Remember to factor in extra for unexpected costs, which can arise during any remodeling project.
Budgeting for Bathroom Renovations:
Similar to kitchen remodeling, bathroom renovation costs can fluctuate based on the size of the bathroom and the degree to which you’re updating it, but here are average costs:
- Basic update (new fixtures, lighting, and paint): $2,500
- Midrange remodel (new tile, cabinetry, vanity, and toilet): $12,000
- High-end renovation (luxury fixtures, adding a shower, custom tilework, layout changes): $30,000
As with kitchen remodels, it’s wise to add a buffer to your budget for unforeseen expenses. Plumbing or structural issues discovered during renovation can quickly increase costs.
Alternatives to Cash-Out Refinancing for Home Improvements
Cash-out refinancing can be an effective way to fund home improvements, but it’s not the only option. Consider these alternatives to determine which financing method best suits your needs and financial situation.
Home Equity Loans
A home equity loan, often called a second mortgage, allows you to borrow against the equity in your home without refinancing your primary mortgage. This typically includes fixed interest rates and a lump sum payment, making it easier to budget for your renovation project. However, keep in mind that you’ll be taking on an additional monthly payment on top of your existing mortgage.
Personal Loans
Personal loans can be a good option for smaller renovation projects or for homeowners who don’t want to use their home as collateral. These loans often have higher interest rates than mortgage-based options, but generally offer faster approval and funding times. They also typically have shorter repayment terms, which can be good if you want to pay off the debt quickly.
Government-Backed Renovation Loans
Several government-backed loan programs are designed specifically for home improvements. For example, the FHA 203(k) loan allows you to finance both the purchase (or refinance) of a home and the cost of its rehabilitation through a single mortgage. These loans can be especially helpfull for homeowners looking to buy and renovate a fixer-upper.
For more information on these and other financing options, check out our guide on how to finance your remodel.
When To Refinance: Before or After Your Remodel?
Timing your refinance around your renovation can impact both the process and the outcome. Think about the following factors when deciding whether to refinance before or after your remodel.
- Current interest rates: If rates are low, refinancing before your remodel might lock in better terms.
- Urgency of renovations: If your project is time-sensitive, refinancing first can provide immediate funds.
- Project scope: For major renovations that significantly increase home value, waiting until after they’re complete might result in a higher appraisal, which we talk more about below.
Impact on Home Appraisal
The timing of your refinance can affect your home’s appraisal value. Refinancing before renovations means your appraisal will be based on your home’s current condition. If you refinance after completing improvements, your home may appraise for a higher value, potentially allowing you to borrow more or secure better terms. However, this requires having the funds to complete the renovations upfront.
How To Use Home Equity for Renovations Wisely
Before making any concrete plans with your new home equity line, consider how to make the most of your money.
Prioritizing Projects
When planning your renovations, start with projects that address essential repairs or improvements. These might include the following:
- Fixing structural issues
- Updating outdated electrical or plumbing systems
- Addressing energy efficiency concerns
After addressing these areas, focus on projects that will add the most value to your home or improve your quality of life.
Maximizing Return on Investment (ROI)
To get the most out of your renovation budget, consider projects known for their high return on investment:
- Kitchen updates
- Bathroom remodels
- Adding a deck or patio
- Replacing old windows or siding
Remember to balance potential resale value with your personal enjoyment of the space. The best renovations are those that increase both your home’s market value and your daily living experience.
Before starting any major renovation project, consider insurance for home construction and renovation projects to protect your investment.
Our Conclusion
Before deciding to refinance, carefully assess your financial situation, renovation goals, and long-term plans for your home. Consider consulting a financial advisor and exploring alternative financing options to ensure you’re making the best choice for your circumstances.