Refinancing can be one of the dumbest things that homeowners do when paying for home renovations - depending on your personal financial situation.

If you’re trying to lock in a significantly lower rate, a cash-out refinance could be a great option for you. But for many homeowners, it can mean throwing money away and getting less out of it.

We get that remodeling can be expensive, and tackling your renovation wishlist could mean that you need to borrow $100,000 or more.

And it’s this realization that can sometimes lead to homeowners abandoning their home improvement plans all together or to borrowing using high interest rate personal loans or credit cards, neither of which should be necessary.

There are other ways to pay for renovations than using a cash-out refinance, and in this guide, we’re going to share the downsides of using a cash-out refinance for renovations, and introduce you to an alternative.

But first, let’s take a look at how refinancing works and the reasons why many homeowners default to this method of financing their renovation, without considering other options.

What Is A Cash-out Refinance?

A cash-out refinance replaces your existing mortgage with a new loan for a higher amount than you currently owe, releasing cash that can be used, amongst other things, to pay for home improvements.

Think of it as refinancing your mortgage and borrowing more money at the same time.

How Does A Cash-out Refinance Work?

In order to use a cash-out refinance, you must have sufficient equity built up in your property, but you won’t be able to tap into 100% of this. Typically, they allow you to borrow up to a maximum of 80% of your home’s value.

Therefore, to calculate how much you could take out with a cash-out refinance, you’d multiply your home’s current value by 80%, and subtract your outstanding loan balance from that amount.

As an example, if your home is currently worth $500k and your mortgage balance is $375k, you could refinance and take out a cash amount of $25k, then use this to pay for home improvements.

Your new mortgage’s balance will be higher than your original one, combining the existing balance with the additional amount that you’re borrowing and closing costs.

3 Reasons Why You Shouldn’t Refinance To Pay For A Renovation

Many homeowners have better financing options available to them to help pay for a renovation than refinancing, and this comes down to three main reasons:

1. You’ll Lose That Low Interest Rate

If you bought your home when interest rates were noticeably higher than they are right now , then a refinance could be a good move.

But today, a lot of homeowners are giving up their low interest rates by refinancing, and paying for it big time.

In fact, a recent 2019 study highlights that the number of homeowners who refinance into a HIGHER rate is as high as 60%, with this often accepted as the necessary trade-off to take cash out of their property.

But as you’ll see below, there are smarter ways to tap into your home equity that don’t require you to refinance into a higher rate.

2. You’ll Have Much Less Borrowing Power

Typically, with a cash-out refinance, you will only be able to tap up to 80% of your home’s current value.

That doesn’t sound too bad until you compare it to home equity loans which can go up to 90% of your home’s current value.

But what’s even better is that RenoFi Loans allow you to borrow up to 90% of your home’s after renovation value. This can make a huge difference to your borrowing power.

Let’s take a look at a comparison, assuming that your home is currently worth $500,000, your current mortgage balance is $375,000 and that the after renovation value will be $750,000. The cost of the renovation is expected to be $250,000.

Here’s how much borrowing power you would have across three different types of financing:

Cash-out Refinance
80% Current Home Value
Home Equity Loan
90% Current Home Value
RenoFi Loan
90% Future Home Value
$25,000$75,000$300,000

If you were to use a cash-out refinance to pay for your remodel, you could only borrow $25k. Say goodbye to the majority of your renovation wishlist.

Using a home equity loan could get you $75k, but that’s still significantly less than you need.

Take out a RenoFi Loan, however, and you could be able to borrow up to $300k based on 90% of your home’s after renovation value. (If math isn’t your thing, that’s $275k more than a cash-out refi).

So to put it simply, if you’re going to tackle a renovation project, choose a financing option that doesn’t limit you from getting everything you really want.

How do I know if a RenoFi loan is right for my project?

The RenoFi team is standing by to help you better understand how RenoFi Loans work and the projects they are best suited for. Have a question - Chat, Email, Call now...

3. You’ll Throw Away Money on Higher Rates & Closing Costs

If refinancing isn’t going to significantly lower your rate, then you’re really just tossing money out the window.

Interest rates aside, you’ll pay closing costs for a cash-out refinance as you would any refinance. These typically range from 2-5% of the entire mortgage amount, which for a $200K loan can be $5,000 - $12,500.

When you compare this to less than $900 in closing costs for home equity loans, it’s pretty clear why we say you’re just throwing money away. By choosing a home equity loan over a refinance, you are saving thousands in closing costs.

Before you choose a cash-out refinance for your renovation project, be sure to do your homework into the alternatives that are available to you.

You’ve already spent however many years paying into a loan, so don’t end up back at square one without any incentive - like a major reduction in your rate.

And, if you decide you do want to refinance to get that major reduction in your rate but are falling short on how much you need to fund your renovation, consider combining a cash-out refinance of your first mortgage with a RenoFi Loan.

Renovation Home Equity Loans: A Better Alternative To A Cash-out Refinance

We’ve talked a lot about RenoFi Renovation Home Equity Loans already, but what are they? And how are they different from a cash-out refinance to pay for your renovation project?

What Is A RenoFi Loan?

A RenoFi home equity loan is a new type of home renovation loan that combines the best elements of a construction loan with a home equity loan, allowing you to borrow based on your home’s after renovation value.

With a RenoFi Loan, you’ll be able to borrow the most money with the lowest monthly payment for your renovation.

And, unlike other home renovation loans, it doesn’t require you to refinance. In fact, RenoFi Home Equity Loans are the only home renovation loans that DO NOT require you to refinance.

This means that you’re able to stay locked into that great rate you’ve secured on your existing mortgage.

It’s also the only type of renovation loan that doesn’t require funds to be disbursed to contractors through a complex inspection & draw schedule process (one of the reasons why contractors hate construction loans).

In fact, a RenoFi Loan is the perfect alternative for homeowners who are considering a home equity loan or cash-out refinance to pay for renovations. By borrowing based on your home’s after renovation value, this can increase your borrowing power by more than 11x.

The main things you need to know about RenoFi Loans are:

  • Loan amounts from $20k to $500k
  • Fixed rates starting as low as 4% (varies by lender and geography)
  • Term up to 20 years
  • Ability to borrow up to 90% of the after renovation value
  • Full loan amount available at closing

Can You Combine a Cash-out Refinance with a RenoFi Loan?

If you’d still like to refinance to lock in a significantly lower rate, you can ALSO apply for a RenoFi Loan to supplement your home renovation financing!

Many homeowners want to refinance to lock in lower mortgage rates, but a cash-out refinance won’t be enough to cover the cost of their dream renovation wish-list. Combining a cash-out refinance with a RenoFi Loan is a great solution.

If that sounds like you, a RenoFi Loan can help! But make sure you’re not refinancing into a higher rate.

Here’s what you can do to combine a cash-out refinance with a RenoFi Loan:

  1. Refinance now, lower your mortgage rate, and take some cash out to cover part of your renovation. You can do that with any lender you’d like.

*(Stay tuned for the RenoFi Cash-out Refinance, a new product that combines the features of a RenoFi Loan, like the after renovation value, with a refinance of your first mortgage. Coming soon!)

  1. Next, come to RenoFi and prepare to apply for a RenoFi Loan with one of our lending partners, that would take the place of a second mortgage, and get the rest of the money you need to cover your renovation cost.

FAQs on Cash-out Refinances for Renovations

It depends - it typically does not make sense to refinance into a higher interest rate to pay for home improvements, but in many cases, homeowners can lower their interest rate and take cash out to pay for home improvements.
RenoFi Renovation Home Equity Loans, RenoFi HELOCs, traditional home equity loans and HELOCs, construction loans, cash-out refinancing, and unsecured personal loans are common alternatives to cash-out refinances for remodels.
Using some methods of financing, like construction loans, FHA 203ks, or Fannie Mae Homestyle loans, you can roll renovation costs into a mortgage.
It depends - it doesn’t make sense to refinance into a higher interest rate to pay for home improvements, but in many cases homeowners can lower their interest rate by refinancing and take cash out to pay for home improvements.
It depends on the rate environment - check with your lender to see if a cash-out refinance makes sense for you.
Generally, you can take out 80% of your home equity (your home value - your outstanding mortgage balance).
No. The IRS doesn’t view this money as income.

 

For more information on RenoFi Loans and how we can help finance your renovation in the smartest way possible, contact us today!

How do I know if a RenoFi loan is right for my project?

The RenoFi team is standing by to help you better understand how RenoFi Loans work and the projects they are best suited for. Have a question - Chat, Email, Call now...