Home values have skyrocketed in the past year, and many homeowners now have a substantial amount of equity. In fact, the average amount of available equity per homeowner is $207,000, collectively $2.8 trillion, according to mortgage technology and data provider Black Knight.
If you’re considering making improvements to your home to combat rising utility costs, you might use a portion of that equity to fund these enhancements. One way to do that: a cash-out refinance for energy-efficient home improvements.
Cash-out refinance for energy-efficiency improvements
A cash-out refinance involves swapping out your current mortgage for a new, larger loan that includes the equity you’d like to pull out in cash, which you can use as you see fit. Your existing mortgage balance and the amount of equity you borrow are both rolled into a single loan, and you’ll make new monthly payments to the lender.
To illustrate, assume your home is worth $425,000 and you currently owe $250,000 on your mortgage. If the lender lets you pull out as much as 80 percent of your home’s equity, you can cash out up to $90,000 to complete energy-saving improvements. When you close, your new loan amount will be $340,000, and you’ll receive the cash generally three business days after that.
You may also be eligible to take the home mortgage interest deduction if loan proceeds are used to make energy-efficient improvements that substantially increase the property’s value. These include permanent additions to the home and upgrades that increase its longevity. Consult with a tax professional for additional guidance.
“If you plan to sell your home in the future and the improvements will add value to your property value, then a cash-out refinance is a great idea,” says Melanie Hartmann, founder and CEO of Creo Home Buyers, a real estate investor based in Maryland. “You can save money on your energy bills and make most, if not all, of the money back that was spent on improving the value of your house.”
Like any other refinance, cash-out refinances come with closing costs, however. If you can’t afford to cover these expenses, it might not be worth it to refinance.
Likewise, if you’ve been in your home for a while and plan to leave in a few years, refinancing to a new loan might not be the best move. You’ll be taking on more debt, and potentially now at a higher rate, which can limit your options if you sell the home relatively soon.
With rates rising, it’s even more important to consider the cost of the project, as well. If you won’t need a substantial portion of your equity to do it, it might be wiser to finance it a cheaper way, such as with a home equity line of credit (HELOC) – more on that below.
Think about the cost relative to the savings, too. How long will it take you to recover your investment?
Cash-out refinance to pay off PACE loans
Cash-out refinances can also be used to pay off PACE (Property Assessed Clean Energy) loans. These are loans offered by state and local governments, payable through property taxes over a 10- to 20-year period. PACE loans are currently limited to residents in California, Florida and Missouri. Work with your lender to determine if you’re able to add the PACE loan to the refinance. If so, the amount you owe will be paid off, along with your existing mortgage balance, as a part of the refinance to the new loan.
Alternatives to pay for energy-efficient improvements
A cash-out refinance is one of many ways to fund energy-efficient home improvements. Consider the following options:
- Home equity line of credit (HELOC): A HELOC allows you to tap your home’s equity as a line of credit, so you’ll get the cash you need to make improvements, but only draw what you need and repay what you use, versus repaying a lump sum. Like a credit card, HELOCs usually have variable rates. Pro tip: Use the savings you earn from the improvements to pay the HELOC. This turns the endeavors into a “self-financing” project.
- Conventional, FHA or VA energy efficient mortgages (EEM): These loan products make it easy to convert a portion of your equity into cash to finance energy-efficient home improvements you’re planning to make or have already completed and paid for through a credit card, HELOC or PACE loan. Fannie Mae HomeStyle Energy renovation mortgages also fall into this category. With this loan, you can borrow up to 15 percent of the “as completed” appraised value.
- Home improvement personal loans: Although they are much more expensive, you might opt to use a personal loan to complete energy-efficiency projects. Personal loans — sometimes billed as “home improvement loans” — are readily available through traditional banks, credit unions and online lenders with terms typically from one to five years. The interest rates can range up to 36 percent, however, so if your credit needs work, this choice might not be best for you.
- Eco home improvement loans: Similar to personal loans, eco home improvement loans are disbursed in a lump sum and payable in monthly installments over a period of time. The key difference is how the funds can be used: You’ll generally be limited to energy-efficient home upgrades. Theer might also request contractor quotes before lending you for financing.
- State and local programs: Check with the Department of Energy in your state along with your local government for any special energy-efficiency grants or financing programs. The US Department of Energy’s Weatherization Assistance Program, for example, offers low-income borrowers weatherization services, such as attic ventilation, solar screens and weatherstripping, to help with energy bills. If you’re eligible, you’ll apply through your state’s weatherization agency. Some utility providers also have their own programs that can help.