Refinancing to pay for a home improvement project

Have you been dreaming about a home improvement project that will add that "something extra" to your home, like a new patio or a kitchen? Home improvements can not only be enjoyable but add tremendous value to your home.

We'll walk through your options to refinance for home improvements, what to consider, the pros and cons and more.

Can you refinance a mortgage to pay for home improvements?

Are you wondering, "Can I refinance for home improvements?"

The simple answer: Yes, you can refinance a mortgage to pay for home improvements, as long as you meet the qualifications.

Refinancing means your lender revises the terms of your old mortgage and replaces your current mortgage with a new mortgage with different terms.

Using a cash-out refinance for home improvements: What to consider

A cash-out refinance is a type of refinance that allows you to borrow money against your home equity. Your lender pays off the original mortgage with an amount larger than your current mortgage balance and you receive the difference in cash between the two loans.

Lenders usually require you to have at least 20% cash to qualify for a cash-out refinance, but that depends on your lender's rules and requirements. For example, if you have $150,000 of equity in your home, you could withdraw $120,000 to use for home improvements.

Requirements for a cash-out refinance

To get a cash-out refinance, the requirements include:

• Credit score: Lenders will check your credit score, just like when you first purchased your home. You'll need to have at least a credit score of 580 to refinance, depending on your lender's requirements and loan type. Refinancing a conventional loan typically requires a 620 credit score.
• Debt-to-income ratio (DTI): You'll usually need a DTI of around 50% or less to qualify for a refinance, though you may be able to have a higher DTI with certain government-backed loans. Your DTI refers to your monthly debts and payments, divided by your total monthly income. For example, let's say your monthly income is $5,000 and you have $2,500 in debt payments per month – in this example, you'd hit the 50% DTI. Your lender will ask for financial documents to prove your DTI (bank statements, W-2s and pay stubs).
• Equity: Your lender will require you to have at least 20% equity in your home for a refinance. The amount you can borrow is typically capped at 80% of your home value – you cannot cash out 100% of your home equity unless you opt for a VA loan refinance. You can build home equity by increasing your home's value or making timely monthly mortgage payments. 
• Loan-to-value ratio (LTV): LTV compares your home's value to what you owe on your mortgage. Aim for an LTV ratio of no higher than 80%, but it may also depend on your lender's requirements.
• Closing costs: You'll also pay closing costs, which are the overall fees associated with your lender processing your mortgage, such as your credit report, title fees or recording fees.

Interest rates for a cash-out refinance

Your interest rate is the amount lenders charge as a percentage of the principal amount. You might be able to get a lower interest rate when you refinance compared to the interest rate on your original mortgage. A refinance typically doesn't carry sky-high interest rates the way credit cards and personal loans might. Shop around and compare your loan options from a handful of lenders to help you secure the right rate. 

Terms and conditions for a cash-out refinance

Look at the fine print your lender provides to understand everything you need to know about the terms and conditions.

You'll typically pay the loan back over 15 – 30 years. Check with your lender about prepayment penalties for paying off your refinance early.

It's important to note that your home acts as collateral on the loan, just like with a regular mortgage. If you quit making your payments, your lender will begin the foreclosure process on your home.

Pros of refinancing for home improvements

The benefits of a home refinance for home improvements include:

• Lowered interest rate: You may be able to tap into a lower interest rate with a cash-out refinance, which can save you money over your loan term.
• Improve your credit: Making on-time payments on your cash-out refinance can improve your credit.
• Tax deductions: The mortgage interest tax deduction can be a major perk. If you have a mortgage, you can deduct $750,000, or $375,000 if married filing separately, in home mortgage interest.
• Use your equity: Instead of letting your home equity lie untouched, you can use it to your advantage by improving your home. When you're enjoying your new kitchen or new master bathroom, you'll likely consider it equity well used.

Cons of refinancing for home improvements

What are the possible downsides of refinancing for home improvements? Let's take a quick look:

• Closing costs: You'll pay for closing costs as part of your refinance, just like you did when you first bought your home. Closing costs will typically cost you between 2% – 6% of your loan amount.
• Owing more: Taking a cash-out refinance means that you borrow more than your initial loan total, which means you'll owe more in principal and interest over the course of your loan term.
• Collateral risk: Just like with your first mortgage, a refinance for home improvement means you could lose your home if you don't make your loan payments. It provides some insurance to your lender that you'll continue to repay your loan.
• Possible payment increase: Your monthly payment may increase with a cash-out refinance because you borrow more than you currently owe on your mortgage. On the other hand, a lower interest rate means your payment may stay the same or go down.

Alternative loan options to a home improvement refinance

There are several home improvement loan alternatives for borrowers. Let's take a look at each:

• Home equity loan: Home equity loans enable you to tap into the equity you've built up in your property. A home equity loan gives you a lump sum loan that you must repay over 5 – 15 years. You can't borrow 100% of your available equity – for example, Rocket Mortgage® will let you borrow 90% of your home equity.
• HELOC: HELOC loans are second mortgages that require you to borrow against your home equity; the house serves as collateral against a line of credit. You make minimum or interest-only payments on this line of credit. When you reach your credit limit, you can borrow more, but you must repay your balance before you do.
• Personal loan: A personal loan can also finance a home improvement project. Personal loans are not backed by collateral, which means that a lender will not foreclose on your home. However, they may have higher interest rates than cash-out refinance loans.
• Government loans: You can also refinance a government loan as an alternative to financing a home improvement project. In fact, you can refinance government loans more quickly than you would a conventional loan, because you can streamline them. This means you might be able to skip certain things, like the appraisal. Learn more about refinancing FHA loans.
• 0% APR credit card: A 0% APR credit card doesn't charge interest for a period of time (the introductory period), usually between 6 – 21 months. The downside is that when the introductory period ends, your credit card interest rate might be much higher.

The bottom line

Does a cash-out refinance make sense for your home improvement? A cash-out refinance might offer a way to tackle expensive upgrades without adding an extra monthly payment to your budget. Consider the requirements, interest rates, pros, cons and alternatives before you decide to use a cash-out refinance for home improvements.

Explore your financing options, including a home equity loan or a cash-out refinance for home renovations. Start the approval process with Rocket Mortgage today.