Erin Gobler5-minute read
UPDATED: November 21, 2022
Doing home improvement projects can increase the value of your home. And more importantly, it allows you to create a space that’s perfect for your family. Unfortunately, renovations are also expensive, and it’s not uncommon for a project to cost tens of thousands of dollars.
The good news is that you don’t necessarily have to save up for the entire project cost or look for alternative forms of financing, often with high interest rates. Instead, you can use your home equity to finance the project, often for a low interest rate and without adding another monthly payment to your budget.
You probably already know that refinancing a mortgage can be a great way to lower your interest rate and your monthly payments. But you may be surprised to learn that it can also be a tool to finance home improvements. Rather than taking out a second loan, you’re simply borrowing against the equity you’ve already built up in your home.
It’s easy to feel skeptical of the idea of increasing the size of your mortgage to pay for renovations. But in addition to creating a space that works better for your family, many home improvements actually increase your home’s value, which means the larger loan is likely to pay off in the long run.
You might find yourself wondering how exactly you can use your home equity to pay for renovations, especially when that money is currently tied up in your house. There’s a special type of refinance loan – a cash-out refinance – which allows you to borrow against the equity you’ve built up in your home during the refinance process.
A cash-out refinance is similar to any other type of refinance loan in many respects. You borrow a new home loan to replace your current mortgage. But instead of borrowing another loan of the same size, you borrow a larger loan and take the difference in cash. You can then use that cash to fund your home improvement projects.
Qualifying for a cash-out refinance loan is similar to qualifying for any other type of mortgage. You can use your current lender, but can also shop around with different lenders to find the best interest rates and loan terms. Just like qualifying for a regular mortgage, lenders will use your credit score to determine whether you qualify for the loan and what rate you're eligible for.
There are several benefits to using a cash-out refinance instead of a different financing option. First, instead of having multiple monthly payments, you continue to make just one mortgage payment. Additionally, because the loan is backed by your home, you may have access to better interest rates than you would with a personal loan.
A cash-out refinance is one of the options available to finance home improvements, but it’s far from the only option. Below we’ll talk about some of the other home improvement loan options available to you.
A home equity loan, like a cash-out refinance, is when you borrow against your home’s equity. The difference is that while a cash-out refinance simply wraps it into your overall mortgage, a home equity loan is a separate loan. It has a separate interest rate, payment term, and monthly payments.
A home equity line of credit (HELOC) is another way to borrow against the equity you have in your home. The line of credit starts with a draw period, which often lasts about 10 years. During this time, you can spend from your line of credit like you would a credit card. After the draw period is the repayment period, during which you’ll have to pay back your loan principal and interest and can’t borrow any additional funds.
A personal loan is a type of unsecured loan, meaning it’s not backed by any collateral. The good news is you don’t risk losing your home if you can’t make your loan payments. Additionally, a personal loan can be used for any purpose. The bad news, however, is that because the loan is unsecured, you’ll likely pay a much higher interest rate than you would with a cash-out refinance, a home equity loan, or a HELOC.
Just as the government offers loans to help certain borrowers buy homes, it also offers home improvement loans. The 203(k) rehabilitation loan allows homeowners to borrow against their home equity to make repairs and improvements to their homes. These loans may be easier to qualify for than other types of financing, while still offering competitive interest rates.
Depending on the type of renovations you’re doing, a credit card with a 0% introductory APR may be an option. Some cards offer 0% APR on all purchases for periods ranging from 12 months to nearly 2 years. The benefit of this option is you won’t pay interest if you pay off the expenses within the allotted introductory period. The bad news is the 0% APR period is much shorter than the term on other types of loans. And if you fail to pay it off before interest kicks in, you could end up paying more than 15% interest on the remaining balance.
It’s clear that when it comes to financing home improvements, you have plenty of options. Below we’ll share some of the pros and cons of using a refinance for home improvements to help you decide if it’s the best option for you.
Renovating your home can increase its value and make it better fit your family’s needs. Home improvements can be expensive, but there are many ways to finance the cost, including using a cash-out refinance. Before using this type of loan to pay for home improvements, it’s important to understand the pros and cons, as well as the alternatives that are available. If you’re considering investing in improvements to your home, be sure to read about current home improvement trends.
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Need cash to make a large purchase? Your home equity gives you options. Learn whether a cash-out refinance vs. home equity loan vs. HELOC is right for you.
Having a solid renovation budget in place can keep your home improvement project on track. Learn how to create a renovation budget and how to pay for it all.