3 reasons why you shouldn't use a cash-out refinance to pay for a renovation

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 is 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 traditional 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 some alternatives.

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 traditional 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.

2. You’ll Have Much Less Borrowing Power

With a traditional 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 traditional 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.

RenoFi offers three different loan options through our lending partners:

• RenoFi Home Equity Loans
• RenoFi HELOCs
• RenoFi Cash-out Refinancing

Let’s take a look at a comparison between a traditional cash-out refinance and a RenoFi Cash-out Refinance, 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:

If you were to use a traditional 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.

Try a RenoFi Cash-out Refinance, 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 traditional 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.

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 traditional 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 a RenoFi Cash-out Refinance

Renovation Cash-out Refinance: A Better Alternative To A Cash-out Refinance

What Is A RenoFi Cash-out Refinance?

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

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

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.

FAQs on Cash-out Refinances for Renovations

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