You have some home renovation ideas swirling through your mind and you want to make them a reality. You have a few options – use your credit card, refinancing your home, or paying cash. While you know that using a credit card could leave you with high-interest rates and a trail of debt for many years to come, refinancing may provide an attractive option. Unless you have the cash lying around, tapping into your home’s equity may be a viable choice.
Keep reading to learn the pros and cons of using your home’s equity for home remodeling projects.
The Benefits of Refinancing for Home Renovation Projects
If you have more than 20% equity in your home, you may be able to refinanceto have money to fix it up. Many loan programs don’t allow you to take cash out of the home if you have less than 20% equity, though, so keep that in mind. The benefits of this method include:
- You may secure a low-interest rate. Today interest rates are lower than in the past. This means you may be able to refinance your first mortgage, take extra cash out with it, and have a lower interest rate. Depending on the original balance and term, you may have a lower payment even while tapping into your home’s equity. This, of course, varies by borrower.
- You don’t have to worry about more than one loan. Unlike a personal loan or home equity loan, a cash-out refinance gives you one loan for your home loan and the renovations. You don’t have to worry about two different due dates, payments, and interest rates.
- You don’t have to deplete your savings. Home renovations can be expensive. If you deplete your savings to fix up your home, you may not have an emergency fund or retirement savings. Even though you may think it’s only a few thousand dollars, if you take into consideration compound interest, you could be losing out on a big chunk of your retirement savings. Taking the money out of your home’s equity leaves your savings alone.
The Disadvantages of Refinancing for Home Renovation Projects
Even if you have more than 20% equity in your home, there are some downsides to consider before you refinance. These include:
- You’ll pay closing costs. You must take into consideration the closing costs on the loan. Some lenders pull you in with a low-interest rate, but then hit you with a lot of fees. In order to avoid this situation, try focusing on the APR. How much will the loan cost you over its lifetime? If the APR seems high, the loan may not be a good idea.
- You may get a higher interest rate. If you obtained your original loan when rates were lower than they are now, you may end up with a higher payment. Even if rates are lower now, but your qualifying factors aren’t the best (low credit score, high debt ratio), lenders may charge you high-interest rates to take cash out of the home because this loan is risky for them.
- You should stay in the home. If you do pull equity out of your home for home renovation projects, you should plan to stay in the home for at least another five years. If you move any time before that, you may experience a loss rather than a decent return on your investment.
If you don’t want to touch your first mortgage, you can opt for the home equity line of credit. This second mortgage does give you another payment to worry about, but they often have lower interest rates. This is also a good choice for borrowers that have a good interest rate on their first mortgage that they don’t want to lose.
HELOCs are often a less expensive option than a first mortgage refinance. The closing costs are often lower and the interest rate can be attractive. You only pay interest on the money you actually use with a HELOC, which can also benefit you if you aren’t sure of the total cost of the home renovation project.
Each borrower will have a different answer regarding if it makes sense to refinance for home renovation projects. Look at all of your options and determine which one will provide you with the lowest payment on a monthly basis as well as cost the least over the loan’s lifetime.