How Does Refinancing for Home Improvements Work?

6 mins read Nov 14, 2024
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Edited By

Megha Mulchandani

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Editor
Edited By

Megha Mulchandani

Editor, Houzeo
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Megha M. is an adept content editor well-versed in the intricacies of American market dynamics and economic trends. In her free time, she excels as a versatile theatre artist and public speaker.

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In 2021 alone, Americans spent $406 billion on home improvements and repairs, an 11.8% rise, nearly three times the average annual growth rate of 4.4%. However, despite the increasing trend in home improvement, arranging for finances remains a struggle. 

In such a case, refinance for home improvement can be an excellent option. This alternative has multiple benefits and a few limitations. In this post, we will evaluate how refinancing can be used to fund different home improvement projects and the things one should be most concerned about. 

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How Does Refinancing a Home Loan Work?

Home loan refinancing is when a new loan replaces an existing mortgage with better terms and conditions, such as lower interest rates or no foreclosure charges. Here is a stepwise description of how refinancing works:

  1. Evaluation of Current Mortgage: The first step is to evaluate the current mortgage, terms and conditions, and remaining balance. It is also critical to finalize the goals of refinancing. It can include a lower interest rate, reduced monthly payments, or cash-out for home improvements or renovations. 
  1. Credit Score Assessment: Refinancing works well when the credit score is healthy (680+). A higher credit score can lead to lower interest rates. Before applying for refinancing, it is recommended that you obtain a detailed credit report and address the issues therein. 
  1. Comparison of Offers from Lenders: There are a large number of lenders who can offer refinancing loans and mortgages. It is advisable to compare conventional (banks and financial institutions) and online lenders for the most competitive refinancing rates.
  1. Application for Refinancing: Once the comparisons are made, apply for refinancing. One might be required to submit different documents, including income, assets, and employment verification.
  1. Appraisal and Underwriting Process: The lender will evaluate the current house’s value, and an underwriter will evaluate the risk levels associated with the submitted application. 
  1. Closure of Existing Mortgage: Once the new application is approved, the existing mortgage agreement will be closed. One might need to pay closing costs, up to 3-6% of the total loan amount. 

Once all the steps are completed, the borrower must start paying regular monthly installments for the new loan at a different interest rate. 

Can I Fund Home Improvements With a Cash-Out Refinance?

A cash-out refinance for home improvement is possible. This is one of the most common objectives for refinancing. A cash-out refinance replaces the existing mortgage with a new one by tapping into the equity (accumulated for real estate investment). 

The amount is more than what is currently owed, and the difference between the two is paid in cash. Typically, lenders require the borrower to retain at least 20% equity in the real estate property after the cash-out. A good credit score and lower debt-to-income ratio increase the chances of receiving a cash-out refinance. 

How Can You Qualify for Cash-Out Refinance?

To qualify for cash-out refinance, criteria set by lenders should be satisfied. The qualification requirements have been underlined as follows:

  1. Home Equity, Credit Score, and Debt-to-Income Ratio: Home equity should be at least 20%, the credit score should be 680+, and the debt-to-income ratio is preferred at 36% or less. 
  1. Requirement of Stable Income and Employment: The homeowner should have a steady income and employment history to be qualified for a cash-out finance application. 
  1. Lender-Specific Requirements: The chosen lender might have additional requirements. A few lenders have a minimum loan amount requirement and specific types of property they refinance.  

Pros and Cons of Refinancing for Home Improvement

Anyone looking for a refinancing option for home improvement should know the alternative’s pros and cons. The following table summarizes the most critical advantages and disadvantages of refinancing alternatives:

Pros:

  • Funds Access: Provides a large lump sum to cover extensive home improvement projects.
  • Potential Lower Interest Rates: The overall interest rates can be lower in case there is a reduction since the first loan was taken.
  • Higher Home Valuation: Remodel loans can lead to improvements, which result in higher home valuation and resale price.
  • Tax Benefits: Homeowners enjoy tax benefits on interest paid on mortgage.
  • Debt Consolidation: There is an option to combine high-interest debt with a low-mortgage loan.

Cons:

  • Closing Costs: The closing costs can be between 3-6% depending on the previous arrangement
  • Increased Debt Levels: Raises the mortgage balance, potentially extending the loan term and total interest paid.
  • Foreclosure Risks: The home can be foreclosed in case of payment defaults.
  • Market Volatility: A downturn in the market can reduce the property’s value
  • Higher Loan Term: The total tenure of the loan automatically increases.

Alternatives to Refinance for Home Improvement Loans

If home improvement loans are not working out for you, you can look into the following options:

  1. HELOC (Home Equity Line of Credit): This arrangement is similar to a credit card. You can borrow against the home’s equity with a revolving line of credit. The borrowing and payment terms are flexible, and interest is paid only on the amount utilized. If you use your home as collateral, you typically face interest rates ranging between 8.64% and 10.72%, which can fluctuate. 
  1. Personal Loan for Home Improvement: Personal loans have a higher interest rate, ranging between 5% and 36%. However, they are easier to obtain, and the amount can be used anywhere the borrower desires for the home improvement. 
  1. Credit Card: A credit card can be preferred for smaller home improvement projects. However, some cards have very high interest rates of up to 40% annually. 
  1. Savings: If you have considerable savings, it can be an excellent way of doing home improvement. It would also enhance the property’s value over time. 

Bottom Line

Refinancing a loan for home improvement or renovation can be a critical financial strategy. It provides funds at a potentially lower interest rate. If you want to renovate your house with limited funding options, this is an excellent option. Besides serving the purpose of improvement, it will also increase your property’s value. 

Smart financing is about aligning renovation goals with a strategy that supports your long-term financial well-being. And that is what Houzeo does for you. Our platform simplifies your search for mortgage lenders near you and helps you find the right one for your needs.

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Frequently Asked Questions

What is home improvement financing?

Home improvement financing refers to the various methods used to fund renovations and upgrades to a home, such as refinancing or loans.

Is refinancing a smart idea?

Refinancing can be smart if it provides lower interest rates, reduces monthly payments, and offers funds for home improvements. But it requires careful consideration of costs and risks.

Does refinancing help increase a property's value?

Refinancing can increase a property's value by providing the necessary funds for significant home improvements and renovations.

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