Cash-out refinance for energy-efficient improvements

While the housing market is showing signs of cooling, home values have skyrocketed in the past few years. As a result, many homeowners now have a substantial amount of equity. In fact, the average amount of available equity per homeowner is $274,000, — up significantly from $182,000 before the pandemic, according to CoreLogic, a consultancy that tracks real estate and property data.

You could leave that money sitting in your home. But 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 improvements.

Let’s take a look at energy efficiency home improvement loans and how one could help you.

Cash-out refinance for energy-efficiency improvements

Any cash-out refinance — including refi loans for energy efficiency improvements — means swapping out your current mortgage for a new 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 against are both rolled into a single loan, and you’ll make new monthly payments to the lender. (Depending on how much equity you have, the new loan could potentially be smaller than your original mortgage, but it will still be larger than the current amount you owe.)

To illustrate, assume your home is worth $425,000 and you currently owe $250,000 on your mortgage. You have $175,000 in equity in your home. If the lender lets you pull out as much as 80 percent of your home’s equity, you can cash out up to $140,000 to complete energy-saving improvements. When you close, your new loan amount will be $390,000 (the $140,000 you’re cashing out plus the $250,000 you still owe on the house), and you’ll receive the cash generally three business days after that.

You may also be able to deduct the interest on the equity you withdraw, if the 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. (If not, you can still take the home mortgage interest deduction on the mortgage portion of the refi.)

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“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.”

Let’s say you’re refinancing a home, and are thinking of installing solar panels, for example. Not only will they likely increase your home’s resale value — meaning you can pocket more when you sell — but they can also lower your energy costs. That means seeing savings year after year.

Important considerations before getting a cash-out refinance

Using refi loans for energy efficiency improvements can make a lot of sense in certain cases, but it’s important to think through your full situation. Before you apply for a refinance, consider:

• Closing costs: Like any other refinance, a cash-out refinance for energy-efficient improvements comes with closing costs. If you can’t afford to cover these expenses, it might not be worth it to refinance.

• Moving plans: 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.

• Mortgage rates rising: As rates are relatively high right now, it’s even more important to consider the cost of the project. 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 (more on that below).

• Return on investment: Think about the cost relative to the savings. How long will it take you to recover your investment? If you live in an area with plenty of sun and you’re refinancing a home with solar panels planned, the dip in your utility bills might help you recoup the money relatively quickly. As you crunch the numbers, though, don’t forget to factor in the interest you’ll pay on your refinanced mortgage.

Alternative loans to pay for energy-efficient improvements

A cash-out refinance is one of many ways to fund energy-efficient home improvements. If you’re looking for energy efficiency home improvement loans, consider the following options:

• Home equity line of credit (HELOC): While a lot of other loans for energy efficiency improvements give you a lump sum, a HELOC allows you to tap your home’s equity as a line of credit. 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: Apply the savings you earn from the improvements to pay off the HELOC balance. This turns the endeavor into a “self-financing” project.

• Conventional, FHA or VA energy efficient mortgages (EEM): These energy efficiency home improvement loans 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 loan terms typically from one to five years. The interest rates can range up to 36 percent, however, so if your credit needs work, it might be best to explore other loans for energy efficiency improvements.

• 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. The lender might also request contractor quotes before approving you for financing.

Cash-out refinance to pay off PACE loans

While you can use a cash-out refinance to make energy efficiency improvements, you might also be able to use these loans for energy efficiency improvements you’ve already made. Specifically, cash-out refis 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.

Ask your lender  if you’re able to add the PACE loan to the cash-out rrefinance. 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.

Government programs that help with energy-efficient home improvements

It never hurts to supplement financing with direct savings, and there are incentives aplenty to make your home energy efficient nowadays.

• State and local programs: Check with the energy department in your state along with your local government for any special energy-efficiency grants or financing programs. The U.S. 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.

• The Inflation Reduction Act (IRA) of 2022 includes dozens of federal tax credits and finances state rebates for different energy-efficient or clean-energy home features, systems and appliances. In general, homeowners can receive a 30% tax credit towards the installation cost of these features, through tax year 2032 (and a lesser amount for two years after that). Eligible features can be as large as a solar roof, or as small as an insulated front door.

Additional reporting by Kacie Goff