Dollars and Sense: How a Cash-Out for Home Improvement Works

Melanie and Douglas Sedam

Looking to make some major home improvements? Consider a cash-out refinance. Refinancing is a low-interest way to get tax-free cash for remodeling your kitchen and/or bathrooms, putting in a pool, or adding a casita.

Let us look at an example. Say you bought your home for $500,000, but you now believe your home is worth more than $700,000. After having the home for a few years, you have paid your mortgage balance down to $400,000. To calculate how much equity you have, simply subtract your mortgage balance from your home value. This leaves you with $300,000 in equity.

But you cannot take all of that out as cash. In most cases, you will need to leave some money in the home to refinance. Assume you can only refinance 80 percent of the value of the home. That means you have the ability to get cash out of your home equal to about $160,000 less closing costs with a new loan amount of $560,000.

When you do a cash-out refinance, the cash you get is tax-free. Yes, you will have to pay it back as part of your mortgage balance, but it is at a much lower interest rate than you might otherwise get with an unsecured loan, such as a personal loan. You can use the cash for home improvements or anything else you need—debt consolidation, tuition, vacation. It is yours to do with as you please.

To take cash out, you need to have a certain amount of equity in your home. When you apply to refinance, your lender will require an appraisal of the property to determine property value. You can subtract your current loan balance from the appraised property value to determine how much equity you have in your home.

A cash-out refinance is a low-cost way to make home improvements when you do not have the money on hand. Refinancing can be a good way to borrow a lot of money at once, which means expensive renovations are in reach and will not take much (if anything) from your monthly budget.

The best time to refinance your mortgage is when interest rates decline. The lower the interest rate you secure, the bigger your savings will be over time and on a month-to-month basis. If you refinance at the right time, you could find yourself in an even better loan than you had before. You could gain access to some of your equity and lower your mortgage payment at the same time. Interest rates are still at an all-time low—as an example I just did a cash-out refinance where my client was returning to college to get his master’s degree. Rather than pay the high interest rates associated with an unsecured student loan he was able to get a rate of just 2.99 percent on a 30-year fixed rate loan!

Improvements can add value to your home. Add a lower interest rate and you will come out ahead if your house is worth more. The right home improvements could make your home more appealing to buyers down the line.

With a cash-out refinance, you will maintain a single mortgage payment that may not to be much higher than the one you have now.

Some people turn to credit cards or personal loans to bankroll home improvements, but those options come with higher interest rates, sometimes in the double-digit range. When you refinance your mortgage, you can borrow money at a much lower interest rate—in today’s market.

Mortgage interest is usually tax-deductible, but the interest on many other types of debt is not. Depending on where you live and the tax rules that apply to you, the interest you pay on your mortgage can be deducted. Check with a tax professional to see how this applies to you.

A cash-out refinance is like any other refinance, which means there are closing costs involved. The closing costs will typically be subtracted from the cash you are getting, so you will not have to pay anything out-of-pocket.

A cash-out refinance can be just the ticket if you are searching for a low-cost way to turn your home improvement list into a finished project or two. To see how much cash you could get from your home, call me to discuss!

Melanie Sedam is a mortgage consultant for The Home Loan Pros that services the mortgage needs of residents in the 55-plus communities of Arizona. You can call her at 520-829-5219, ext. 2.