by Dusty Brazil
CA BRE #01780273
Pacific Sotheby’s International Realty
Del Mar, CA 92014
Are you looking for cash to pay for the renovation on your home? One of the most popular sources of cash today is a cash out refinance on your home, which can provide you with the money you need for major home upgrades. Refinancing to a new lower rate may mean that your payment will not substantially increase and may even drop, depending upon the rate and how much money you are pulling out. But if you are going to do a cash out refinance and renovate, there are some important tips that can help make it go smoothly:
#1 Cash Out Refinance Is Often Better than a HELOC
When you are pulling equity out of your home, you have the option of doing a cash out refinance or taking out a line of credit on your current mortgage. Both of these strategies have their uses. A home equity credit line or HELOC is useful if you want to pull money out of your home over a longer period. It works just like a credit card; you have a line of credit up to a certain amount that you can use in the draw period, which is usually 10 years. However, a HELOC’s interest rate is variable, and it is locked in only for a certain period of time. It can go up substantially when the draw period ends. Also, HELOC rates can be frozen, reduced or even terminated for several reasons. The most common is if you make late payments. Worse, it can happen if the value of your home falls. If you are nervous about the adjustable interest rates that come with the equity line, then consider a home equity loan.
Cash out refinancing always has the same interest rate, and once you have the cash, you have the cash. You can do whatever you like with it. Just be sure that the renovations you are making are worth doing. Consider FHA for a cash out refinance, as you only need 15% equity to qualify in many instances.
#2 Research the Best Renovations to Do
If you are pulling equity out of your home, you want to be sure that the renovations that you are doing will get you most of your money back when you sell. For example, putting money into the kitchen usually is money well spent, if you don’t go overboard. You do not want to put $100,000 into your kitchen if the home is only worth $200,000; you will never get your money back when you sell. But if you upgrade the cabinets, flooring, counters and sink, the total cost might be $25,000 or $30,000. That type of upgrade on a $200,000 can make a lot of sense when it is spent on the kitchen. Remember, you want to do renovations that will pay you back when you sell. Making the house more livable while you are in it is important, but you want to get your money back when you leave the home.
Other good upgrades to consider are:
- Renovating the master bath
- Adding a bathroom
- Adding square footage
- Making windows more energy efficient
#3 Consider a 15 Year Mortgage
Depending upon your job and your income, you may want to think about refinancing into a 15 year mortgage. If you are saving a good deal on your interest rate, the increase in payment may not be as high as you think. On some 15 year mortgages, you can get an interest rate that is at least .5% lower than a 30 year loan. This can save you tens of thousands in interest over the life of the loan.
#4 Keep Track of Your Mortgage Interest for Tax Purposes
Most homeowners who have a mortgage are able to tax deduct their mortgage interest to save themselves big at tax time. When you do a refinance for cash back, you will be able to tax deduct the interest on the new loan in most cases. This is one of the biggest advantages of using your equity for renovations. You can tax deduct all of the interest that you are paying. If you paid for those renovations on a credit card, you would not be able to tax deduct that interest. This easily will save you a thousand or more in taxes.
Considerations When Doing a Cash Out Refinance
Generally, using your equity for renovations make a lot of sense, but as with anything, it can go south if you make some of these mistakes:
- Spending equity on renovations that will not pay you back when you sell. You need to be careful about making the home too nice for your neighborhood. As we noted earlier, if you have a $200,000 home, spending hundreds of thousands on it will never pay you back. You need to keep the renovations and upgrades realistic if you ever want to see that money again.
- Closing costs. Any time you do a mortgage, you will pay closing costs. You can expect to pay 3-6% in closing costs on a cash out refinance.
- Risk of foreclosure. When you do a cash out refinance, you are increasing your monthly payment in most cases. There are many examples of people who pulled cash out of their home to do renovations but could no longer keep up with the mortgage payments. If you lose your job or your hours are cut, will you be able to handle that extra monthly payment?
- Be careful of using that money for things other than renovations or uses that will turn a profit. Some people will use their equity from a cash out refinance to pay off credit cards. This can be a bad idea because it simply enables bad behavior.
A cash out refinance to do home remodeling can make sense, if you are able to secure a low interest rate and have a firm, good plan on what you are doing with the money. Just be sure that you are spending the money on things that will turn a profit later. Or, at the very least, will pay you back what you put into the renovations.