You want to renovate your home in the near future to make it more suitable. But you’re also considering refinancing and aren’t sure if you should hold off on making improvements until the new loan closes.
Ultimately, deciding if you should refinance before or after completing home renovations depends on what you’re trying to accomplish. If you’re seeking a lower interest rate, a more affordable monthly payment or both, you can hold off until the home improvement projects or repairs are complete. But if you’re planning to convert your home equity to cash and use the funds to make improvements, you’ll need to refinance before the renovation.
The Basics of Mortgage Refinancing
Refinancing your mortgage can provide the funding needed to make costly home improvements.
What is Mortgage Refinancing?
Mortgage refinancing involves swapping out your existing home loan with a new one. The reasons for refinancing can vary but often include getting a more attractive interest rate, lowering your monthly mortgage payments or changing the loan term. It can also allow you to access your home’s equity for renovation projects through a cash-out refinance.
How Does Refinancing for Home Improvements Work?
When you opt for a cash-out refinance specifically for home improvements, the new mortgage loan is for a larger amount than your current mortgage. You can use the difference between the new larger loan and the remaining balance of your existing mortgage to fund renovations.
Here’s a closer look at the lending process if you choose to move forward with a refinance to cover home improvement costs:
- Get a home appraisal: A licensed professional assesses your home’s value to determine how much equity you have.
- Secure a new loan: Borrow more than what you currently owe.
- Receive the difference in cash: After the existing mortgage is paid off, the remaining amount is given to you in cash.
Factors to Consider to Decide If You Should Refinance Before Or After Renovations
Your Financial Status
You must have enough equity in your home to borrow against. If your property appraises for a higher value after renovations, the cash you can take out will increase.
The Current Housing Market
Keep an eye on the interest rates, as refinancing can reduce your monthly payments when they are lower. If rates are expected to rise, refinancing before renovation could be ideal. And if home values are rising, waiting until after the renovation could lead to a better appraisal and more favorable loan terms.
Your Long-term Plans
If you plan to stay in your home for many years, refinancing before renovation may provide a more immediate benefit to your living space. If you’re considering moving soon, consider the return on investment for renovations when refinancing.
Reasons to Refinance Before a Renovation
Here’s a closer look at why it’s a good idea to refinance before upgrading your property.
Access Cash to Fund the Renovation
A cash-out refinance lets you pull equity out of your home that can be used to cover renovation costs or however else you see fit. It also replaces your current mortgage with a new one with different terms. To illustrate, assume the lender allows you to borrow up to 80% of your home’s current value. If it’s currently worth $500,000 and you owe $325,000 on your mortgage, you could cash out up to $75,000 ($500,000 * .80 – $325,000).
When you close on the loan, the new lender will pay off your current mortgage of $325,000. You’ll also receive the cash you pulled out, which will be added to your current mortgage balance, bringing the new mortgage (or new loan amount) to $400,000 ($325,000 + $75,000).
Expand the Renovation Project
Significant renovations are often costly, and there’s a chance you may not have several thousands of dollars lying around to get them all done. Consequently, cutting corners or scaling back the project scope may seem like the most feasible solution. Or you can take out a cash-out refi to cover the costs or add even more items to the list of upgrades to avoid higher interest rates that often come with other forms of debt, like credit cards and personal loans.
Lower Monthly Payments
If you’re looking to secure more favorable loan terms or remove private mortgage insurance, a rate and term refinance could be a smart financial move before renovating your home. You could get a more affordable mortgage payment for two reasons: you qualify for a lower interest rate, and the term resets on the new loan. Keep in mind that an extended loan term means the lender has more time to collect interest from you.
Still, if you’re not in a rush to renovate, the money saved by reducing your mortgage payment could be used toward home improvements.
Avoid Using High-Interest Debt
Refinancing before a renovation can help you avoid relying on high-interest debt options like credit cards or personal loans to fund your home improvements. By accessing the equity in your home through a cash-out refinance, you can secure a lump sum of cash with potentially lower borrowing costs than other financing options. This approach can be more cost-effective and allow you to begin your renovation project without the burden of high-interest debt accumulating over time.
Reasons to Refinance After a Renovation
Sometimes, it’s more sensible to make improvements after seeking a refinance.
Increase Home’s Value and Equity
Renovations will likely increase the value of your home and the amount of equity at your disposal. Consequently, it will appraise at a higher value when you apply for a cash-out refinance, which means you could be eligible to pull out more cash.
Take Out More Cash
To piggyback off the last point, if your property value is $275,000, you owe $150,000, you’ll receive $83,750 ($275,000 * .85 – $150,000) if the lender lets you pull out 85% of your home value. But assume you invest $25,000 of your own cash to make improvements. If your property appraises for $375,000 after renovations, the amount of money you can take out will increase to $168,750 ($375,000 * .85 – $150,000).
Lock In A Lower Interest Rate
Refinancing after a renovation also allows you to lock in a lower interest rate than you had previously, especially if market rates have decreased since you closed on your current loan. A lower interest rate can mean considerable savings over the life of the loan. It can also lower your monthly mortgage payments to make them work better for your budget. This is particularly beneficial if you’ve made substantial improvements to your home, as it could further enhance the financial benefits of the renovation.
Conclusion: Deciding When to Refinance Your Mortgage
When considering a refinance for home improvements, evaluate your financial position carefully. Assess the following factors:
- Interest Rates: Ensure rates are lower than your original mortgage to justify the costs associated with refinancing.
- Home Equity: Confirm you have enough equity built up in your home. Typically, you need to retain 15 percent to 20 percent in equity after the refinance.
- Tenure in Home: Plan to stay in your home long enough to recoup the closing costs through the savings on your new mortgage.
- Closing Costs: Understand that refinancing includes closing costs and fees, which can add up.
- Current Debt-to-Income Ratio: Lenders will review your debt-to-income ratio, so confirm it is within acceptable limits to qualify for refinancing.
- Future Value: Ideally, the renovations should enhance both your quality of life and the property’s market value.
Before moving forward, review the terms and conditions carefully and seek professional financial advice to ensure that refinancing makes sense and aligns with your long-term financial goals. Also, carefully weigh the pros and cons of each approach to decide which is best.
