Low interest mortgage rates have given some homeowners the option toÂ refinanceÂ their mortgage and free up extra cash, either through lower monthly mortgage payments or a â€œcash outâ€ refinance in which they borrow against the equity in their home.
Homeowners can use this money in a variety of ways, including paying off debt or paying for their childrenâ€™s college expenses. But is it a good idea to use this extra cash for home repairs or renovations?
We askedÂ Kathryn Hauer, a financial counselor in Aiken, South Carolina, andÂ Roslyn Lash, a financial counselor in Winston-Salem, North Carolina, for their views. Hauer and Lash are members ofÂ NerdWalletâ€™s Ask an AdvisorÂ network.
Roslyn Lash:Â One of the main advantages of refinancing is to receive a lowerÂ mortgage rateÂ that reduces the overall cost of the loan, which ultimately results in a savings. Refinancing could easily allow a person to â€œcash outâ€ with enough funds for home repairs without an increase in the mortgage payment.
For example, if you received a 30-year, $200,000 mortgage at 6% five years ago, your monthly payment is $1,200, excluding taxes and insurance, and your current balance is $186,109. If your home repairs are estimated at $10,000, a cash-out refinance may be the best option to renovate the property without straining the familyâ€™s budget.
You would take out $10,000 in the refinance, giving you a new mortgage of $196,109 at an interest rate of 3.5% for a 25-year loan. That would result in a payment of $982. Youâ€™d pay off your home as originally scheduled and saveÂ $218 a month.
Kathryn Hauer:Â If you get cash back in addition to your refinance, you could end up with a higher monthly mortgage payment, depending on how much you take out. You donâ€™t want to reduce your savings rate â€” for example, contribute less to your 401(k) â€” as a result of a refinance.
Roslyn Lash:Â Once you add the fees into the loan amount, the total cost of refinancing could outweigh the actual benefits. YouÂ must carefully analyze the numbers toÂ determine if refinancing is the best option. To get a realistic estimate of the total cost, itâ€™s imperative to getÂ a loan estimate from each potential lender. This estimate will not only provide total cost, but getting one from a couple of lenders will provide a true comparison of fees.
Kathryn Hauer:Â Refinancing can be a better option than aÂ HELOCÂ if you plan to stay in your home for more than five years and if you can refinance to an interest rate lower than your current rate. If you think you might move soon or if your current mortgage rate is already low, a HELOC would probably be a better choice.
Roslyn Lash:Â Determining the best option between refinancing or a HELOC depends on your individual financial situation. If you haveÂ a mortgage of 3.8%, for example, itâ€™s unlikely that refinancing would benefit you, since your rate is already low. In this case, your best option would be a HELOC, if the monthly payments are affordable. Each individual must take into account the current interest rate, remaining term and mortgageÂ balance, as well as income and other debts. A careful analysis of these figures will determine the most affordable and feasible option.
If the costs of a planned home repair or renovation are minimal, and the monthly payment is within the household budget, it may be more economical to get a HELOCÂ because some of the traditional fees may not apply. Of course, the disadvantage to getting a HELOC is the obligation of a second, although smaller, mortgage.
Roslyn Lash:Â Look closely at the interest rate as well as the fees. Itâ€™s not uncommon for a lenderâ€™s interest rate to be low, but for the fees to be excessive. This strategy lets consumers think theyâ€™re getting a good deal when in actuality the cost of the â€œone-timeâ€ fees eats away at their overall savings. Compare each lenderâ€™s annual percentage rate. The APR provides an accurate comparison because itÂ combines the refinance rate and the fees.
Kathryn Hauer:Â Shop around for the bestÂ refinance ratesÂ and donâ€™t forget to evaluate the deals at your local credit union. Also, make sure you reduce outstanding credit as much as possible and pay your bills on time in preparation for the application process so you get the best rate possible.
Roslyn Lash:Â Refinancing could let you get rid ofÂ private mortgage insurance premiums. When the mortgage was initially taken out, if the homebuyer didnâ€™t contribute at least a 20% down payment, PMI was included in the payment, resulting in a higher mortgage payment. However, as the mortgage balance decreased and property values increased, itâ€™s possible that the PMI could be eliminated, thus further reducing the payment.
Kathryn Hauer:Â Be honest with yourself. Are these home repairs that you want â€” replace an ugly but functional patio â€” or that you need â€” repair a leaking roof? Sometimes you have repairs that are necessary and unavoidable, so if you plan to stay in your home for a few more years, a refinance could be the perfect solution. However, you donâ€™t want to refinance only to put in a swimming pool that the children quickly outgrow, while you scrape up cash to cover your higher payments plus the kidsâ€™ college tuition.
Kathryn HauerÂ is a financial counselor and founder ofÂ Wilson David Investment AdvisorsÂ in Aiken, South Carolina.
Roslyn LashÂ is a financial counselor atÂ Youth Smart Financial Education ServicesÂ in Winston-Salem, North Carolina.
This article originally appeared onÂ NerdWallet.