Many people who ask for a mortgage want to borrow enough money to cover the purchase price of the home they are buying (less any down payment they are able to provide). But what if the house you buy needs some improvement? If so, you might be tempted to take out a higher mortgage.

Here is how it might work. Suppose your house costs $ 200,000. You have $ 50,000 for a down payment. So you plan to borrow only $ 150,000. However, this is a larger down payment than your lender will charge. Most lenders are more than happy with a 20% down payment. For this example, a 20% down payment would only be $ 40,000. In that case, you could just put in less money ($ 40,000 instead of $ 50,000), get a larger mortgage ($ 160,000 instead of $ 150,000), and use the remaining funds (the 10,000 additional dollars that you did not use for your down payment) to cover home improvements.

If you already own a home and want to do some renovations, you can take out a larger mortgage. To do this, you would do a cash refinance. When you refinance a mortgage, you are swapping an existing loan for a new one. Suppose you have $ 150,000 left on your mortgage. With cash-out refinancing, you could take out a new loan of $ 170,000. The first $ 150,000 would go towards your original mortgage, and the remaining $ 20,000 would be yours for home improvements (or other purposes).

Both of these options will give you access to the money you need to improve your home. But is taking a bigger mortgage a good idea?

Reasons for taking out a larger mortgage

Suppose you qualify for a larger mortgage or cash refinance. It might pay off to take this route because:

1. You may be able to borrow affordably

Mortgage rates today are extremely low. If you finance your renovations through a higher mortgage, you could save a fair amount of money. Case in point: On July 7, the average interest rate for a 30-year fixed mortgage was 3.35%. On the same day, the average interest rate on a home equity loan was 5.18%.

2. You benefit from tax relief

The interest you pay on your mortgage is deductible if you itemize it on your tax return. If you take out a home equity loan or line of credit to pay for home renovations, that interest is also deductible. But if you decide to stick with a lower mortgage and then fund your renovations through a Personal loan, you will not be allowed to deduct your interest.

Reasons not to take out a bigger mortgage

On the other hand, getting a bigger mortgage has its pitfalls:

1. Higher monthly payments

The larger the mortgage you take out, the more money you will have to pay each month. It’s not a bad thing if you can afford those monthly payments, but if borrowing more means stretching yourself financially, you risk losing your home and damaging your credit if your higher payments cause you to fall behind. ready.

2. You might be tempted to over-improve your home

Money is often a barrier to home improvement. If you take a bigger mortgage and get easy access to cash, you can renovate as you wish. This is not necessarily a good thing. Many homeowners are at risk of over-improving themselves, investing so much money in their home that when they go to sell, they don’t come close to getting their investment back. If you are borrowing more than you need to cover the purchase price of your home, you might feel pressured to go all out. It could improve your quality of life while you live in your home, but it could ultimately be a bad financial decision.

What is the right call for you?

If you are able to lock in a truly competitive environment mortgage rate on an initial home loan or cash refinance, then it might pay off to borrow extra to cover home renovations, especially if you’ve planned those renovations and figured out what they will cost. But if these renovations are hypothetical, you haven’t priced them, and you’re not even sure you want to complete them, you might want to put the extra borrowing on hold.

Once you take out a higher mortgage, you agree to repay that loan. You will immediately begin to earn interest. It doesn’t make sense to shoulder that extra expense if you’re indifferent to those home improvements to begin with.