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I currently own a home with a mortgage at 4.25%. I'm five years into a 15 year loan. My wife and I would like to sell within the next three years and we have almost 50% equity in the house. We would likely need to do some repairs/ updates such as remodeling both bathrooms and replacing all the windows. Would it make sense to refinance to a 30 year loan at 3.875% and borrow to do some of the renovations. I'm thinking that reduced mortgage payments would give us extra cash until the house is sold. Assume we lose 15% equity to pay for the renovations. Would this be a sensible plan?

  • Not what you asked, but you should also consider whether remodeling before you sell is a good idea. If you spend $5,000 remodeling the bathroom, say, will this result in you getting $5,000 more when you sell than would have been the case otherwise? Realtors tell me that the answer is almost always "no", the increase in value to the house is almost always less than the cost of renovations. Of course if you are planning to live in the house for some time, the value of the improved renovations to you is a different, and highly subjective, question. – Jay Dec 11 '14 at 20:22
  • @Jay the remodel is really to repair numerous issues, such as leaking tub, vinyl flooring curling near the tub and other areas, grout crumbling / tiles coming off, etc. – Andy Dec 11 '14 at 22:29
  • @Jay that said, I was going to have a realtor come through before doing any work in anticipation of a sale. – Andy Dec 11 '14 at 22:30
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When evaluating a refinance, it all comes down to the payback. Refinancing costs money in closing costs. There are different reasons for refinancing, and they all have different methods for calculating payback.

One reason to finance is to get a lower interest rate. When determining the payback time, you calculate how long it would take to recover your closing costs with the amount you save in interest. For example, if the closing costs are $2,000, your payback time is 2 years if it takes 2 years to save that amount in interest with the new interest rate vs. the old one. The longer you hold the mortgage after you refinance, the more money you save in interest with the new rate. Generally, it doesn't pay to refinance to a lower rate right before you sell, because you aren't holding the mortgage long enough to see the interest savings. You seem to be 3 years away from selling, so you might be able to see some savings here in the next three years.

A second reason people refinance is to lower their monthly payment if they are having trouble paying it. I see you are considering switching from a 15 year to a 30 year; is one of your goals to reduce your monthly payment? By refinancing to a 30 year, you'll be paying a lot of interest in your first few years of payments, extending the payback time of your lower interest rate.

A third reason people refinance is to pull cash out of their equity. This applies to you as well. Since you are planning on using it to remodel the home you are trying to sell, you have to ask yourself if the renovations you are planning will payoff in the increased sale price of your home. Often, renovations don't increase the value of their home as much as they cost. You do renovations because you will enjoy living in the renovated home, and you get some of your money back when you sell. But sometimes you can increase the value of your home by enough to cover the cost of the renovation. Talk to a real estate agent in your area to get their advice on how much the renovations you are talking about will increase the value of your home.

  • Not to pick nits, but in the US mortgage interest is tax deductible, so effective interest rates are lower depending on the tax bracket. This just means you need a bigger reduction in the interest rate before the closing costs are paid for. – Nathan L Dec 12 '14 at 17:54
  • As an update, one of the refis offered by my credit union only have a $300 closing cost. Seems like that payback shouldn't take much. – Andy Jan 16 '15 at 2:15
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In the first years of a loan, most of what you're paying is interest, so my guess is that this is a bad idea. But there are lots of mortgage calculators offered for free on the web (your bank's website may have one) so I'd suggest that you spend some time running actual numbers before deciding.

Reminder: Most renovations do NOT pay for themselves in increased sales price, not least because you'll lose the buyers who don't like what you've done but would have been happy to renovate it themselves to their own tastes. Unless there is something which will actively impair your ability to sell the house, you should usually renovate when you plan to stay there for a while and take your returns in enjoying the house more, NOT on the way out.

(There's been some recent discussion of this over in Home Improvement, pointing out that the changes which return more than they cost are usually simple things like refreshing the paint, "staging" the house so it looks lived in but not cluttered, replacing damaged blinds, washing windows, putting out a few more flowers, and so on.)

  • If I'm only going to have the refi for a couple of years (and I'm ok with only having 35% equity), why is it a bad idea that id be paying mostly interest? the renovations are for things that would hurt the sale, such as windows not closing properly (double hung, cannot be repaired) and such. – Andy Dec 11 '14 at 2:39
  • Paying mostly interest means the money just goes away, as opposed to actually paying down the loan and increasing your net profit when you sell. It may work, it may not work, run the numbers on exactly what you're planning. There is no universal answer, and if we go into all the details here I think it'll go out of scope. – keshlam Dec 11 '14 at 2:56
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    @andy Once you pay a dollar of interest, that money is gone. When you pay a dollar of principle, then that is one dollar less you have to pay when you pay off the loan. That money is yours forever. – Jay Dec 11 '14 at 20:24
  • Understood, but I anticipate that there may need to be expensive repairs to be done before selling, so where to get the money from? I'd need some kind a loan in all probability, would a HELOC be a better option? – Andy Dec 11 '14 at 22:37
  • Home Equity Line Of Credit strikes me as a better bet. Any idea what the total cost would be and how long it'd take you to pay off that loan? This is all formulas; you shouldn't have to guess. – keshlam Dec 11 '14 at 22:43

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