How to Make Financial Sense When Remodeling Your Home

Ian Mutuli
Updated on

When you remodel your home by making improvements like renovating your kitchen, adding an additional bathroom, or replacing your property’s exterior siding, you can greatly increase the value of your home; as well as improving its aesthetic and comfort. But if you need to borrow money to make those improvements, it needs to make financial sense. One of the best ways of remodelling your home in a way that makes financial sense is to go with a cash-out refinance scheme.

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Refinancing Your Mortgage

Refinancing your mortgage to pay for the renovations you want to make is one of the best financial strategies available to you. Current mortgage rates, as of June 2021, are around 3.13% for a thirty-year fixed mortgage rate, 2.41% for a fifteen-year rate, and 2.63% for an adjustable-rate mortgage. You can use the excellent comparison site Moneywise to compare refinance mortgage rates from different mortgage lenders. If you are pursuing a cash-out refinance option for remodeling your home, you need to know what the refinance mortgage rate will likely be.

When you refinance your mortgage, you basically pay off the loan to your original mortgage lender and then use a new lender that has entirely new loan terms. That will typically include a new interest rate, which will ideally be a lower rate, as well as a new payment term and closing costs. If you are in a position where you have built enough equity in your home, you can apply for the cash-out refinance option. It basically means you borrow more than your original mortgage and then receive the difference at closing. The amount of equity you may borrow will vary from one lender to another, which is why it is important to compare different insurers, but most enable you to take out a mortgage that is up to 80% of the value of your home.

So, how does cash-out refinance actually work?

To help you understand the cash-out refinance option better, let us take a look at an example. If you purchased your home five years ago for a price tag of $250,000 and you made a down payment of $10,000, and your mortgage payments have reduced your existing loan to $200,000, your home would today be valued at $305,000. Seeing as the majority of mortgage lenders allow for an 80% loan-to-value ratio, it means you could potentially refinance your mortgage and get a new mortgage for $244,000. Your previous mortgage lender only needs to be repaid the sum of $200,000, thus leaving you with $44,000 to complete your home renovations. However, bear in mind that other factors will determine the precise amount, such as your level of debt, your income, and your credit score.

The Advantages and Disadvantages of Cash-out Refinance

While a cash-out refinance option is a great solution for remodeling your home, there are both advantages and disadvantages of cash-out refinancing. On the downside, your monthly mortgage payment will be higher and the repayment term will be longer. The latter also means you are paying interest on the loan for a longer time, which can add up over the years. A cash-out refinance can also mean you will be older than you initially thought you would be by the time you can completely pay off the loan. On the upside, when you use cash-out refinancing, the interest rates will typically be lower in comparison to the rates via a credit card or personal loan. And your monthly payments could be much more affordable because they are spread out over a longer time. But the best thing about the cash-out refinance option is you have the funds to improve your home and therefore add value to it

Ian Mutuli

About the author

Ian Mutuli

Founder and Managing Editor of Archute. He is also a graduate architect from The University of Nairobi, Kenya.