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Discover Home Loans: How Refinancing for Home Improvement Works

Home improvement rarely ever comes cheap, but there's a way to turn that expense into an investment

Home improvement rarely ever comes cheap, but there’s a way to turn that expense into an investment. A mortgage refinance from Discover or another home lender essentially replaces one mortgage with another, and a cash-out refinance is a type of mortgage refinance that enables homeowners to convert a portion of their equity to cash, which can then be used to pay for a home improvement project, among other uses. 


Cash-out refinances are very common tools to use for financing home improvement projects, and with interest rates remaining low, now may be a better time than ever for homeowners to make improvements. 


How does a cash-out refinance work?


A cash-out refinance replaces a current mortgage with a new one, and also lets the borrower convert some of the equity in their home into cash. That cash can be used for almost anything. The borrower still needs to pay off the loan over time, but they will do so as part of the new mortgage. Meanwhile, borrowers can use the cash to improve their home, possibly increase its value and prepare to sell it for a potential profit down the road.


How to see if a cash-out refinance is a good option for home improvement projects


How much is needed?


The first step is to determine what sorts of home improvement projects are to be completed and how much they will cost. Borrowers may want to focus on fixing the roof, building a deck, finishing the basement, or a combination of things. 


How much can be borrowed?


After setting the goals, it’s time to see how much a cash-out refinance would cover. In order to qualify for a cash-out refinance, one usually needs to have built up at least 20% equity in their home and have a good credit score (generally above 650) and debt-to-income ratio (at least 50% or lower). Assuming the borrower meets the eligibility requirements, many lenders will offer loans up to 80-90% of the current value of the home. 


A portion of that loan will be used to pay off the old mortgage plus closing costs, and the rest of it will be a lump sum of cash that the borrower has instant access to.


Forecast the return on investment


After configuring how much is needed to borrow to cover the expenses, it’s time to forecast the return on investment. 

Calculate how much the renovations will potentially increase the value of the home, plus how much the home may appreciate in value in the time between the present moment and when the house is to be sold. 

Then, find the difference between the cost of refinancing and the payoff of selling the improved home. 

Based on these calculations, homeowners may want to adjust when they will sell their home, which home improvement projects will be worth the investment, and how aggressively they may want to pay off the new mortgage. 


The bottom line


A cash-out refinance is a great option for home improvement if homeowners plan to stay in the home long enough to recoup the investment, and/or if the home improvement will increase the value significantly enough to make a profit. 

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