Should You Refinance Before or After Renovations?

It can be stressful to raise the cash to finance a home renovation project, which is usually why those projects get put on hold. 

As you consider refinancing your mortgage to pay for your home renovations, be sure to reduce your outstanding credit as much as you can and pay your bills promptly before you apply so that you can get the best interest rate possible. You will be able to make small, consistent payments throughout the term of the loan instead of having to exhaust your savings. That is one advantage of refinancing your mortgage for home improvements.

What improvements will you make?

Make a list of the things you like and dislike about your home. Rethink your current lifestyle and how each room is used, and whether there is any space, you would like to improve. Refinancing your home mortgage may be the best way to fund your big home renovation projects without compromising your other financial goals. However, your improvements may not justify a mortgage refinance if they are small and more manageable.

Hire a Contractor Versus Do-It-Yourself

DIY allows you to save money, but you need to consider the complexity of a project, what tools you'll need to complete it, how confident you are with your ability to execute the project, and how important it is to your home. 

Whenever possible, connect with friends/family who has recently renovated and ask them for recommendations based on your needs. Compare quotes from different contractors to ensure you're getting the best deal. Make sure you choose the right contractor (from a skillset or even personality perspective) before you start the renovation project to avoid a lot of extra stress.

Renovation Benefits

Renovating a home can be stressful, but the result should be fulfilling. A new main bedroom, a brand new bathtub, or new kitchen countertops all deliver a unique sense of excitement and can significantly grow your home equity. Most renovations will increase the value of your home, increasing your home equity and helping grow your wealth.

Renovations: Return on Investment

As well as investing in your dream home, completing home renovation projects will add value to your house. The first time you buy a home is typically the largest investment of your life, so renovations that increase its value always make the most sense, especially if you use refinancing to pay for it. When deciding whether to stay put until your kids graduate from college or if you plan to live in the house for the foreseeable future, you should consider the return on investment of each home renovation project that you take on.

After Refinancing

When your home undergoes a major renovation, its value will increase. Refinancing after this may sound nice, but you may not be sure if it's a good idea. If the right circumstances exist, refinancing a mortgage after a home renovation can be quite advantageous. Whether you decide to refinance depends on what your goals are. 

Here are a few things you might want to keep in mind when considering refinancing and if you should do it before or after renovations.

Cash-Out Refinancing

A cash-out refinance occurs when you refinance your mortgage for a higher amount than what is owed on the home, but less than its total value. The reason some homeowners choose this method is to get cash from their home equity and/or a lower interest rate on their mortgage. 

The difference between the value of the old loan and the new loan will be paid to you in cash. You can use this for whatever you want, including funding renovations before they start, or after they are completed.
 

Consider the value of your house after renovations are complete. Compare this with your loan balance to determine how much equity you may have available after renovations. The cost of refinancing is high, and lenders will only allow a percentage of the home's value to be borrowed. So ask yourself, is there enough equity in your home to fund the renovation work?

Secondly, interest rates need to be compared. The average personal loan interest rate is significantly higher than loans that are secured with home equity. 

How much will you save in interest by paying off the personal loan and increasing your mortgage balance? In addition to those savings, there will be closing costs associated with refinancing. Calculate which approach saves the most money.

Cash-Out Refinancing Requirements

You and your house must meet a few specific requirements before you can consider a cash-out refinance. The credit score you'll need to be considered for such loans is around 620, but the exact score you'll need will vary depending on the type of loan and the amount of money you're borrowing.

Having a certain amount of equity in your home will also be a requirement. Your lender will require a property appraisal if you are refinancing. The amount of equity in your home is determined by subtracting the loan balance from the appraised value. You typically need between 15% and 20% equity, although the minimum requirement varies by lender.

As part of your refinancing application, your debt-to-income ratio will be considered. You calculate this by combining your recurring monthly debt and dividing it by your gross monthly income. You'll typically need a debt-to-income ratio of 50% or less, although lenders will vary.

Refinancing to Remove Private Mortgage Insurance

Your loan might also be eligible for PMI refinancing, so you don't have to pay PMI anymore. Refinancing will remove the need to pay for PMI and likely get you a lower interest rate, helping you reduce your monthly expenses significantly. PMI is required for borrowers who can’t submit a down payment of 20% or more. 

Depending on the loan type, it may be possible to remove PMI without refinancing the loan. To find out the home's current market value, you need to get an appraisal. Check your loan documents to determine if PMI can be removed or if the loan needs to be refinanced.

Refinancing After Renovations: More thoughts

It is common for mortgage decisions to be influenced by various factors. Essentially, interest rates and cost are the two most important factors to consider when refinancing. Both up-front and down the road costs are covered, along with savings. Making realistic calculations can help you make better decisions about financing your home by looking at the big picture.

For more information on mortgage refinancing in Ontario, call Canadalend at 1-844-586-0713 or contact us here.