Should You Cash-Out Refinance for Renovations in This Market?

Mortgage rates have dropped gradually over the last few weeks. That’s good news for borrowers seeking to refinance their existing mortgage loan and lock in a lower rate – especially homeowners who want to liquidate home equity and fund home improvement projects via a cash-out refinance.

But is now a good time for a cash-out refinance? Have rates dropped enough to make pulling the trigger worth it? Are market conditions currently favorable for a cash-out refi? This article will attempt to answer these and other important questions.

In this article (Skip to...)

• What is a cash-out refinance?
• Are current market conditions favorable?
• Benefits of a cash-out refi
• Drawbacks of a cash-out refi
• Alternative financing options

What is a cash-out refinance?

A cash-out refinance involves replacing your current mortgage with a new, larger one, with the difference between the old and new loan amounts given to you as cash at closing. This option allows you to access your home’s equity for any purpose and is an excellent way to secure a large amount of money at low interest rates.

To qualify for a cash-out refinance, you’ll need to meet similar requirements as homebuyers applying for a new mortgage, including evaluation of your credit, financial situation, and property. Specific requirements may vary by lender and loan type, but generally, you’ll need more than 20% equity in your home, a new appraisal to confirm its value, a credit score of at least 620, a debt-to-income ratio (including the new loan) of 43% or lower, a loan-to-value ratio of 80% or less, and proof of income and employment. These criteria are standard for most conventional cash-out refinances.

Be aware that changing interest rates and housing market trends can impact the costs and benefits of a cash-out refinance.

Are current market conditions favorable for a cash-out refinance?

Refinance activity is recently on the rise, including cash-out refis. But that doesn’t necessarily mean current market conditions are ripe for pursuing this option or that a cash-out refinance is ideal for you. Let’s explore various factors that can signal if a cash-out refi is currently worthwhile.

Interest rates and their impact

The overall cost of a cash-out refinance is strongly impacted by mortgage interest rates.

“Locking in a rate now could save you money if rates are predicted to rise because higher rates mean higher interest payments over the course of the loan,” explains Steven Kibbel, a certified financial planner. “However, if the market anticipates a rate fall in the future, waiting may result in a lower interest rate and lower overall borrowing expenses.”

If rates reverse their trend and go up, however, locking in sooner could be a wise move.

“Timing the market is tricky, and locking in now offers more predictability,” suggests Carl Holman, director of Communications and Content at A&D Mortgage.

Home equity trends

Rising home values increase the amount of equity available for a cash-out refinance, enabling homeowners to borrow even more. But if home values begin to decline due to broader economic pressures or a housing market correction, that borrowing potential could shrink, cautions Holman.

Consider that home prices have been elevated for some time. Homeowners have remained in their homes much longer than average, which means they are sitting on more home equity.

“With mortgage rates the lowest they’ve been all year, now is a very good time for customers to consider using that equity to get a cash-out refinance, possibly using it to fund home improvements as well as consolidating some of their higher interest debt and improving their overall credit profile,” notes Nina Gidwaney, head of Refinance and Home Equity at Chase Home Lending.

Inflation and renovation costs

Renovation timing can also be affected by inflation and the growing expenses associated with home improvements.

“Waiting things out longer could increase the cost of renovations if inflation keeps raising the price of supplies for home repairs,” Kibbel continues. “By locking in a cash-out refinance rate now, you can reduce the chance that expenses will rise and finish your improvements before inflation drives up prices even more.”

Economic uncertainty

Broader economic factors, such as the Federal Reserve’s choice to cut or raise rates, also play a crucial role in refinancing decisions.

“If further rate cuts are anticipated, it might make sense to wait and benefit from a lower interest rate environment in the future. However, there is always the uncertainty of how quickly those cuts might happen, and inflationary pressures may still push rates higher in the near term anyway,” adds Holman. “For those needing immediate access to cash, waiting for potential rate cuts could be a gamble.”

The benefits of using a cash-out refinance for home renovations

There are many advantages provided by a cash-out refi when paying for home improvements. Here’s a roundup of these plusses.

Access to large amounts of cash

As home values continue to rise, many homeowners now enjoy substantial equity they can liquidate for larger-scale renovations that might otherwise be unaffordable.

“Cash-out refinances can provide the money you need for your current goals. Maybe in addition to making home renovations, you want to save for college or retirement or purchase that big-ticket item you’ve been dreaming about,” Gidwaney says.

Lower interest rates compared to other financing

Interest rates are always fluctuating. If rates dip further or your financial situation has improved, you could be eligible for better rates and terms than you may currently have in the form of a cash-out refinance.

“A cash-out refi often comes with lower interest rates compared to other types of financing like personal loans or credit cards, which makes it a more affordable financing option for larger projects,” Holman points out.

Potential tax benefits

Keep in mind that the mortgage interest charged on a cash-out refinance loan could be tax-deductible if your funds are used for home improvements – providing yet another layer of financial advantage.

Opportunity to increase home value before selling

Home improvements can raise your property’s value, which could result in a higher asking price when it comes time to list your home for sale.

The risks and drawbacks of cash-out refinancing in today’s market

On the other hand, there are disadvantages to pursuing a cash-out refi right now. Let’s explore each of these.

Extending mortgage term or higher payments

If you refinance to a longer term, this resets the clock on your mortgage, potentially adding years to your repayment schedule and increasing the total interest you will pay over the life of the loan.

Or, if you shorten your loan’s term, chances are your monthly payments will be higher.

“Yes, your cash-out may refinance may result in higher payments than your previous mortgage. You need to make sure the terms of the loan align with your budget,” recommends Gidwaney. “Also, be aware that a cash-out refinance may also come with a slightly higher interest rate – one-eighth to one-quarter percent higher – than a standard refinance.”

Risk of over-borrowing

It’s easy to get in over your skis when it’s convenient to tap into available home equity and receive a tempting lump sum at closing.

“Be careful you don’t withdraw more money than you require, which can result in unneeded debt,” cautions Kibbel.

Closing costs

Perhaps the biggest disadvantage of committing to a cash-out refinance is that you are required to pay closing costs. These can average 2% to 6% of your loan amount, which decreases the amount of equity you are actually able to access.

Imagine you pursue a cash-out refi for a new loan amount of $400,000; that means your closing costs can tally $8,000 to $24,000. If your lender permits it, you can always choose to roll the closing costs into your loan in the form of a higher borrowed amount or a higher interest rate, but that means you’ll probably pay a lot more in total interest over the loan’s term.

Risk of losing your home

Your lender will require using your home as collateral. Consequently, you risk losing your home to foreclosure if you can’t make your payments on time. Be sure you can afford your new monthly payments and enjoy relatively stable job security.

Alternative financing options in the current market

A cash-out refinance isn’t the only option available. If you want to fund a home renovation project, consider these alternative forms of financing.

Home equity line of credit (HELOC)

A HELOC offers a convenient way to tap into your home’s equity without the need to refinance. Unlike a home equity loan, a HELOC functions more like a credit card, allowing you to borrow up to a preapproved limit, repay it, and borrow again if necessary.

“A home equity line of credit allows you to have access to flexible, revolving borrowing as needed,” says Kibbel.

One key distinction is that HELOCs come with adjustable interest rates, which can fluctuate over time, but interest is only charged on the amount you’ve borrowed, not the full credit limit.

Home equity loan

A home equity loan lets you borrow against the equity in your home, which is determined by subtracting your outstanding mortgage balance from your home’s current value. Unlike a cash-out refinance, a home equity loan doesn’t replace your existing mortgage. If you already have a mortgage, you’ll continue making those payments in addition to the payments on the new home equity loan.

“Home-equity loans are fixed-term loans with lower interest rates than personal loans, and they are also secured by your house,” Kibbel notes.

Personal loans and other financing

A personal loan, also known as a signature loan, is an unsecured loan that doesn’t require physical collateral like a home to secure repayment. Instead, the lender typically just needs your signature and promise to repay. Since personal loans are unsecured, the reason for borrowing is usually less important, and qualifying can be relatively easy, with funds available in just a few days. However, because no collateral is involved, lenders view personal loans as riskier and often charge higher interest rates compared to secured loans. Additionally, missing payments or not following loan terms can hurt your credit score, making it harder to get future credit.

There are also secured personal loans available that require putting up collateral like a home or car; this option may come with a lower rate than an unsecured personal loan.

Is now the right time for a cash-out refinance? Key considerations

Now that you are up to speed on factors that can impact a cash-out refinance, as well as their pros, cons, and alternatives, the question again arises: Should you commit to a cash-out refi soon? The experts advise pondering the following considerations carefully before making your decision.

Current market conditions

Thoroughly analyze the current state of interest rates, the worth of your home, and local market conditions before proceeding.

“Rates are a lot higher now than they were a few years ago. So even if you are getting a slightly better rate than what’s advertised, it might not be worth it,” cautions Matt Schwartz, co-founder of VA Loan Network. “Fees and closing costs can really add up weekly, making the overall cost of borrowing much higher.”

Your long-term goals

Ask yourself: Are you planning to stay in the home long enough to make the refinance worth it? Let’s consider a break-even scenario. The smaller the drop in your mortgage rate, the less you save each month, meaning it takes longer to recover your closing costs and begin realizing real financial benefits. For instance, lowering your rate by 0.5%—from 6.75% to 6.25%—could save you around $122 per month on a $400,000 mortgage. While this is a solid monthly savings, it might take over three years to break even on closing costs, so it’s important to ensure you’ll keep the refinanced loan for at least that long.

“Additionally, evaluate how the refinance will fit into your overall financial plans, including any debt reduction goals and other objectives you have – not just home renovation aspirations,” Kibbel recommends.

Renovation urgency

“If you need the funds now and your renovation is urgent, a cash-out refinance could be a good option. However, if the project can wait, it could be worth holding off for a while, as there’s a good chance interest rates may decrease further – presenting a better financial opportunity for refinancing down the road,” suggests Justin Haywood, president/co-founder of Haywood Wealth Management.

The bottom line

Crunch the numbers carefully and weigh all your options and scenarios to better determine if the time is right for a mortgage refinance involving cashed-out equity.

“Consider the total cost involved, including closing fees, the potential for higher monthly payments, and whether your home’s value is likely to increase or decrease after you make the renovations,” Holman says.