Good purposes for the cash you get from a cash-out refinance are so numerous that we could write about a different one every day all year. In the face of all the possibilities, every homeowner has different priorities. Paying off expensive credit card debt is a favorite use of cash-out refi, as is settling medical bills. Home improvements and repairs will always rank high on the list too.
But have you considered developing a rental unit with a cash-out refinance so that your new renter ends up making your mortgage payment? Whether you have a garage conversion, a guest wing, or a tiny house on your property, the rental income from such a full-featured space could match your mortgage payment.
Many Renters to Choose From
Home prices soared over the last year to reach unpredictable highs, preventing renters who want to buy from buying, and keeping them renters. "Soaring building material costs, high demand, and low inventory have added tens of thousands of dollars to the price of a new home and caused housing affordability to fall to its lowest level in nearly a decade during the second quarter of 2021," says the National Association of Home Builders.
Buyers are scrambling for fewer quality properties and paying a lot once they find them, well above asking price. Not every responsible adult wants to play that game. Rather than take on long-term housing debt today with the possibility of being upside-down in the mortage later (owing more than the home is worth), many people rent while they wait for the market to return to balance.
More than one-third of U.S. residents rent their home. Most are under 45 years old and have attended college.
One of these responsible, patient people could be your new renter and pay off your mortgage.
Financing a Rental Unit With a Cash-Out Refinance
We are not talking about renting a spare bedroom to a college student. The unit should have its own entrance, a kitchenette, and certainly its own bathroom in order to command enough rent. Necessary renovations are paid for by the cash-out refi. For example, dividing a guest bedroom and bath from the rest of the house and giving it its own entrance off the street, or adding an efficiency kitchen to a converted garage.
The more accommodating the unit, the higher the rent. Take a look at your existing space with a mind toward what renovations would increase its rental potential, knowing that you can fund the renovations with a cash-out refi. Ideally, you and the renter will enjoy separate, firmly delineated spaces. You will be a happier landlord this way, and your renter will expect to pay for the autonomy and privacy.
Tiny House, Big Rental Income
Maybe you don't have any rental space yet, but you have a large yard. A typical build price for an impressive tiny home (an independent dwelling with bathroom and kitchen and less than 400 square feet of floor space) is $35,000, going by the budgets shared on Tiny House, Big Living, to name just one TV series that follows the creation of someone's dream mini-dwelling.
A $35,000 price tag happens to be in the ballpark of the common amount of cash people get from a cash-out refinance. The exact amount you can get depends on your home's value, and lenders commonly tout amounts from $25,000 to $50,000. Generally, lenders will limit the cash you can take out to 80%-90% of your home's recently appraised value, but you won't need anywhere close to that much to build a good tiny house.
The best part is that because of today's low mortgage rates, you can benefit from a cash-out refi without raising your payment one penny! Read on to see how it's possible.
How Can the Payment Stay the Same?
Low rates tilt the mortgage equation greatly in favor of refinancers. The remarkable benefit of a lower interest rate is that you can borrow enough to pay off the old mortgage, add $40,000 or $50,000 in cash, and keep your payment the same. Even after paying the closing costs up front (say, $8,000), you net $42,000 in cash.
Where did the money come from? It came from your home. When the loan term and payment do not get higher, it's clear that the cash came from your equity.
Here is an example. Let's say that eight years ago you borrowed $325,000 at 4.39%, a competitive rate then. Your payment has been $1,626. You currently owe around $277,000.
Now with 22 years to go on that mortgage, you seize the opportunity to refinance. You borrow $317,000 at 2.89% so that you can pay off the old mortgage and take $50,000 in cash. The new mortgage term is 22 years to match the old. Your new payment is $1,624.
Developing premium rental property on-site, like with a well-converted garage or a tiny house, is a boss-level home improvement because a cash-out refinance can pay for it and then the rental income can pay your mortgage. Since your renter has their own entrance, bathroom, and kitchen, you will hardly know they are there. With today's low mortgage rates, you can build a tiny house on your property with cash from a refinance without raising your payment or adding years to your term.