Cash-out refinance mortgage: Good way to finance a remodel?
Iris Price | Improvement Center Columnist | December 8, 2014
If you weathered the recession with a high-rate mortgage and with little or no equity left in your home, you may finally be able to come up for air and swim for shore. You may be in a position to take advantage of some of the enticingly low mortgage rates that reappeared in October 2014. Maybe you are even thinking, "What if I could kill three birds with one stone?"
- Snag a significantly lower interest rate on a new first mortgage
- Pull equity out of your home to make upgrades you've wanted since 2008
- Increase your home's value by financing one of the best remodels for ROI
What you might be looking for is a cash-out refinance mortgage. You are not alone. According to Freddie Mac, 28 percent of mortgage refinances in the third quarter of 2014 were cash outs. That's a significant increase from 14 percent for the same period last year, but still a far cry from the 80 percent of homeowners who a decade ago were refinancing and cashing out multiple times, using their homes as an income stream by taking advantage of soaring home values and burgeoning equity.
Limitations on how much equity you can borrow -- as of December 13, 2014, Fannie Mae has reduced the limit of loan-to-value ratio from 85 to 80 percent -- and stricter qualifications for borrowers make cash-out mortgage refinance tougher than before the housing debacle. But once interest rates start to rise again, you may be hesitant to give up an already low-interest mortgage to access your equity, so the time to look at a cash-out is now.
3 reasons to choose a cash-out refinance mortgage
A cash-out refinance mortgage could allow you to accomplish all of the following in one fell swoop, depending on your circumstances:
- Lower your mortgage interest rate. With interest rates low and bouncing even lower once again in October and November, homeowners with mortgages at higher rates may be thinking about saving on interest payments. Refinancing pays off your mortgage obligation and replaces it with a new mortgage at a different interest rate. However, you are "resetting" your payments and terms, starting all over again from year one with your new mortgage -- another 30 or 15 years all over again, according to the terms of your mortgage. You also, in most cases, have to pay new closing costs. You should do the amortization calculations before deciding whether refinancing is financially sound for your situation.
- Tap the equity in your home. If you have been paying down your current mortgage for a few years -- and with the housing market picking up steam and home values in many places on the rise again -- you may have again built up equity in your home after being under water during the recession. By borrowing against that equity -- if it's sufficient in comparison to what you currently owe and what the home appraises for today -- you may be able to pull some of that unrealized cash out when you refinance. For example, if you owe $200,000 remaining on your current mortgage and your home is now worth $300,000, you have $100,000 equity in your home, the difference between what you still owe and your home's appraisal value. There are limits to how much of that you can tap -- generally no more than 80 percent of your equity -- and, of course, you have to pay it back. It becomes part of the total you are borrowing, and even with lower interest rates, your monthly payments are likely to increase, depending on how much equity you cash out. However, because it's a loan and not income, all or at least some of it in most instances, may not be taxable. Consult your tax advisor regarding your potential tax liability, if any.
- Provide cash to finance a high-ROI remodel. While you are free to do anything with the cash you pull out -- including pay your children's tuition, consolidate debts, travel -- many homeowners are opting to reinvest that money in their homes. Remodeling Magazine's Cost vs. Value report for 2014 shows that the average return on investment for every remodeling project they follow from year to year increased nationwide. Higher returns on remodeling investments have plenty of homeowners considering cash-out refinance mortgages to make a major remodel financially feasible.
Why a cash-out refinance might not be your best choice
There are other mortgage products and financing options suitable for funding a remodel. One of the more popular choices is to secure a second mortgage in the form of a home equity line of credit (HELOC), for example. With a HELOC, you don't have to reset your first mortgage and start from square one with the length of your mortgage terms or delay payment of your principal. Here are some of the other reasons you may not want to consider a cash-out refinance:
- You plan to sell your home in the near term and won't recoup the closing costs in that period of time.
- You don't have enough equity in your house to cover the cost of your remodel plans. Get bids from three qualified contractors so you have a range of what your remodel might cost before applying for a cash-out mortgage.
- You already have a low (or lower) interest rate and with added closing costs, you won't save enough in interest costs to offset the new mortgage's closing costs, which in some cases can be substantial.
- The cash-out won't leave you with enough money to fully cover the costs of your remodel.
Plenty of homeowners are rushing to cash in on cash outs, but do your homework first. If it makes good financial sense, you might soon be celebrating with your head above water -- from your new luxury soaking tub in your remodeled bath.
Photo credit to Kevin Irby