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Home renovation financing can be an extremely stressful process. Those who missed out on business school might feel lost, and may even consider forgoing a project that could potentially increase the value of their home because they do not want to take the risk of being taken advantage of by financiers. There are countless ways to finance your remodel, so let’s lay out the basics first.
While it may seem far too obvious, if you have enough cash flow or are planning far enough ahead, you can do home renovation financing with your own cash. This avoids all interest charges, bank fees, secured loan foreclosures (if your house is the collateral), and wasted time. Your contractor will probably love you for paying in cash, too, which never hurts.
Secured vs. unsecured loans
Since it was mentioned above, let’s cover secured and unsecured loans. Simply put, a secured loan provides “security” for the bank in the form of a tangible item. In almost all home renovation cases, your house will be used as the collateral. This means that if you cannot pay your secured loan, the bank can foreclose on your house. This extra “security” for the bank means that they will be able to offer you better interest rates because of the asset gained if you default (are unable to pay) on your loan. Unsecured loans have no security via a tangible asset, but almost always come with a high-interest rate.
Unsecured loans and credit cards
Recommended for: low-cost projects, people with extremely high credit scores, and other special circumstances
The only time these options are recommended is for projects with a low cost, usually those less than $10,000. If you are able to pay back the total of your project in less than three months, a credit card might be the way to go. The sum of the interest payment made can cost less than the closing costs and fees associated with bank loans. Furthermore, if you recently opened a credit line that offers zero percent introductory APR (interest rate for an entire year), home renovation financing this way can be a good option.
Home equity loans
Recommended for: one-time projects, fixed-budget renovations
Often the most popular option, home equity loans generally provide the most benefit for those taking on one-time projects above the $10,000 range without the necessary cash on hand. Generally speaking, these loans come with a fixed APR, meaning no matter whether interest rates rise or fall, that is what you will pay on your loan. This is currently advantageous for consumers, as interest rates are projected to rise in the coming years. Interest rates are also tax deductible up to a million dollars (on home remodel loans specifically). Closing costs will have to be paid, as well as any bank fees. You could also lose your house if you fail to make a payment.
Home equity lines of credit (HELOC)
Recommended for: long-term projects, continual renovations
This type of loan is most easily described as a combination of a home equity loan and a credit card. As with a home equity loan, your house is used as the collateral. However, the bank allows you to withdraw money on demand (with a few restrictions) for an agreed amount of time (called a draw period). The loan has a variable interest rate, meaning the rate can rise and fall with changes in the trading market (to learn more, check out the end of our article Rises in Property Taxes (and other costs) May Put Renovators’ ROI in the Red). The benefit of HELOCs is presently diminished due to rises in interest rates, but can still be useful on projects that require cash infusions over a long period of time.
Title 1 loans
Recommended for: low-equity renovators, nonresidential renovations
Those who don’t have a lot of equity (i.e. have a large amount left on their mortgage) in their home may be denied a home equity loan. These renovators can look to Title 1 loans as an option. They work in the same way as home equity loans but are backed by the federal government and have some limitations. Nonessential items are not allowed (think saunas and the like) and the maximum single family amount is $25,000. This program can also work for small business owners who need cash to renovate or build an area for a small business.
Recommended for: periods of low-interest rates in the market, rising home prices
Refinancing is increasing your mortgage amount and receiving the difference in cash. If your current mortgage interest rate on an average fixed 30-year mortgage is higher than 4 percent, the current average rate reported by CNN, then refinancing could be a way to not only get the cash you need for your renovation but also receive a better rate while you are at it. Now is a great time to consider the refinancing option, as economists expect to see falling house prices in the coming years.
Be careful with these loan options
All subprime loans
Subprime lending goes to individuals with a credit score lower than 640. It comes with higher interest rates, sketchy terms, and hidden costs. These loans are never a good deal – they caused the housing market collapse a few years ago. Work on improving your credit score if you find yourself considering this option, or seek alternative ways of financing your projects, such as borrowing from a trusted friend or relative.
Most contractor-offered financing
There is a reason that these guys swing hammers and don’t sit behind a desk at a bank all day. While most contractors are completely trustworthy, and some might have your best interests at heart, there are others who are looking to make a quick buck. Contractors can work deals with financiers for kickbacks through hidden fees, costs, and transaction-related expenditures. Unless your contractor is a trusted friend, or you have used him/her before, it is better to find your own financing and let the contractor do what he/she is supposed to do – renovate your home.
Home renovation loans, FHA 203k loans, and any other renovation-specific loans
This category comes with shades of gray. Most of these loans are good in theory. In fact, the FHA 203k loan was set up to sell homes that were poorly taken care of and in need of significant work, giving this option the nickname “the rehab loan.” The FHA 203k wraps the cost of a mortgage and a home renovation loan into one bundle at a very low-interest rate. This saves on closing costs and removes the headache of organizing loan payments. A great idea, but the loan requires specific attributes from buyers, like high credit scores and a specific debt-to-income ratio. The paperwork can also take a long time, up to six months in some cases. Time is money in the renovation game, and a six-month delay could completely shut down a project. Additionally, some financiers who offer these favorable loans require that you use their personal collection of approved contractors, which are not always the best. If you decide to move forward on a specialized loan, you should talk to a trusted finance professional about your options.