Cash-Out Refinance For Energy-Efficiency Improvements

Home prices have skyrocketed in recent years, resulting in many homeowners having significant equity. In fact, as of the first quarter of 2024, the average U.S. homeowner will have $305,000 in equity after purchasing their home, according to CoreLogic, a consultancy that tracks real estate and wealth data.

you Done Keep that money in your home. But if you’re considering home improvements to combat rising utility bills, you could also use some of that equity to cover the costs of those improvements. One way to do this is to do a cash-out refinance for energy-efficient renovations.

Let’s take a look at energy efficiency improvement loans and how they can help you.

What is a cash-out refinance for energy efficiency improvements?

A cash-out refinance means exchanging your current mortgage for a new, larger loan. You receive the difference (based on the size of your equity) in cash to use as needed. Both the balance of your existing mortgage and the amount of equity you borrowed are combined into one loan, and you make new monthly payments to the refinance lender. Depending on how much equity you have, the amount of your new loan may be smaller than your original mortgage, but it will still be larger than the amount you currently owe.

You may also be able to deduct the interest on the property you drew down if you used the loan proceeds for energy-efficient upgrades. This includes permanent additions, renovations, and improvements that extend the life of your home. (If not, you can take a mortgage interest deduction on the mortgage portion of your refinance.)

“If you plan to sell your home in the future and your renovations will increase the property’s value, a cash-out refinance is a great idea,” says Melanie Hartman, founder and CEO of Maryland-based real estate investor Cleo Home Buyers. “You’ll save money on your utility bills and get back most or all of the money you spent to increase the value of your home.”

For example, let’s say you’re refinancing your mortgage and you’re thinking about installing solar panels. Not only will solar panels increase the resale value of your home, meaning you get more money for it when you sell, but they’ll also reduce your utility bills, meaning you’ll save money every year.

What to consider before getting a cash-out refinance

Taking out a refinance loan to pay for energy efficiency improvements (or any home improvement) can make a lot of sense in some cases. But it’s important to think it through. Before you apply for a refinance, consider the following:

• Closing costs: Like any refinance, a cash-out refinance for energy efficiency improvements will have closing costs. If you can’t afford these costs, it may not be worth it to refinance.
• Moving Plan: If you plan on moving in a few years, refinancing into a new loan may not be the best idea, as it will increase your debt and require you to pay it off with the proceeds from the sale of your home.
• rise Mortgage interest rates: Interest rates currently remain relatively high, making it even more important to consider your borrowing costs. Refinancing makes little sense if it would mean paying significantly higher interest rates. If you want to use your ownership interests to pay for your project, it may be wise to seek financing in another way, such as a mortgage or line of credit (more on this below).
• Return on investment: Think about the cost versus the savings. How long will it take to recoup your investment? You may be able to recoup your money relatively quickly if your energy bills go down, but don’t forget to factor in any mortgage interest you’ll incur in your calculations.

Cash-out refinance vs. mortgage: Which is better for energy improvements?

The best way to cover costs associated with energy improvements will vary greatly depending on the total cost of the project, your payment plan for that cost, and your current mortgage interest rate.

A cash-out refinance can be a good choice if you have a specific, important project in mind, because it gives you access to a lump sum of funds. But if your existing mortgage interest rate is particularly low, it may not be the best option, especially if current interest rates are rising. You could end up paying a higher interest rate on your mortgage. It also has higher upfront costs, since you’ll have to pay the settlement costs associated with refinancing your entire mortgage.

“Nearly 90% of mortgage borrowers in the U.S. have interest rates below 6%,” says Steven Cates, CFP, principal financial analyst at RetireGuide. “Refinancing your entire mortgage can mean higher interest rates and be significantly more costly than keeping your existing mortgage and taking out a smaller loan for the amount you need.”

In that case, mortgage and Home Equity Line of Credit (HELOC) A HELOC, a type of loan that also allows you to borrow against your ownership stake, may be a better option. HELOCs in particular offer flexibility for longer-term projects (like rewiring your entire home or installing a solar roof) because you can withdraw funds as needed during the drawdown period, says Andrea Altamirano, vice president and mortgage program manager at Sunrise Bank. “If the renovations are relatively small and can be done over time, a HELOC may be a better choice,” Altamirano says. “The flexibility and low upfront costs are an advantage.”

HELOCs also have lower upfront costs than cash-out refinances. You may not even need a title search or home appraisal. Variable-rate HELOC rates tend to be a few percentage points higher than refinance rates. But because you’ll be paying that interest in smaller installments, it can still be a dollar value advantage.

Alternative Energy Efficiency Home Renovation Loans

Cash-out refinancing is one of many ways to fund energy-efficient home improvements. If you’re looking for an energy-efficient home improvement loan, consider the following options:

• Energy Efficiency Mortgage (EEM): These are loans to purchase or refinance a home that meets certain energy efficiency requirements, or to retrofit a home to be more energy efficient. These can be conventional loans, FHA loans, or VA loans. You can borrow up to 15 percent of your home’s appraised value to make energy efficiency improvements.
• Fannie Mae/Freddie Mac Renovation mortgage: Fannie Mae’s HomeStyle Renovation loan and Freddie Mac’s CHOICERenovation loan allow borrowers to purchase a home that needs repairs or refinance their existing mortgage to fund the renovations. Repairs or renovations cannot exceed 75% of the appraised value of the home after the renovations.
• Home renovation loan: Although it’s much more expensive, you can also get a personal loan to complete your energy efficiency project. Personal loans, sometimes called “home improvement loans,” are easily available from traditional banks, credit unions, and online lenders, and loan terms typically range from one to five years. However, interest rates can be close to 36 percent, so if you need to improve your credit, it may be best to consider other energy efficiency loans.
• Eco Home Improvement Loans: Similar to a personal loan, an eco home improvement loan is paid in a lump sum, which is repaid in monthly installments over a period of time. The main difference is how the funds are used, which is generally limited to energy-efficient home improvements. Lending institutions may also ask contractors for quotes before approving the loan.

Cash-out refinancing to pay off PACE loans

You can use cash-out refinancing to make energy efficiency improvements, but you may also be able to use these loans for energy efficiency improvements you’ve already made. Specifically, you can use cash-out refinancing to pay off a PACE (Property Assessed Clean Energy) loan, which is a loan provided by state or local governments that you pay back through your property taxes over 10 to 20 years. PACE mortgages are currently only available to residents of California, Florida, and Missouri.

Ask your lender if you can add a PACE loan to a cash-out refinance. If you can, the amount you borrow will be paid off along with the balance of your existing mortgage as part of the refinance into your new loan.

Government programs to support energy-efficient home renovations

Supplementing your finances with some direct savings is never a bad thing, and there are plenty of incentives to start making your home more energy efficient right now.

• State and local programs: Check with your state energy department or local government to see if there are any special energy conservation grant or loan programs. For example, the U.S. Department of Energy’s Weatherization Assistance Program provides low-income borrowers with weatherization services such as attic ventilation, solar screens, and weather stripping to help them save on their energy bills. If you qualify, apply through your state’s weatherization agency. Some utility companies also have their own programs that can help.
• Inflation Control Act of 2022 (IRA)The law includes dozens of federal tax credits and covers state rebates for a variety of energy-saving or clean energy home fixtures, systems, and equipment. Generally, homeowners can get a 30% tax credit on the installation costs of these fixtures through tax year 2032 (with a reduced credit for the two years thereafter). Eligible fixtures range from big things like a solar roof to small things like an insulated front door.

Additional reporting by Mia Taylor