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Renovation Financing

By on May 15, 2014
Renovation Financing

Renovating your house–whether it’s building an addition, giving the kitchen a facelift or finishing the basement–adds to your quality of life and increases the resale value of your home. Renovations can cost tens of thousands of dollars, and there are several financing options available. The one you choose depends on several factors:

  • Amount
  • Current home equity
  • Drawing on the money all at once or as you go
  • Making amortized payments or on a flexible schedule
  • Putting a second mortgage on the home

Your first step should be getting pre-approved by a lender so you’ll know exactly how much you have to spend. Here are your financing options:

A home equity loan works much like a conventional first mortgage. You borrow a lump sum that is secured against your home, and the payments are amortized over several years. Usually, the interest rate and monthly payment remain fixed throughout the term of the loan. This option requires an additional payment on top of your first mortgage and usually carries a higher interest rate than refinancing your mortgage. However, the closing costs may be lower and it can be right if you don’t want to refinance and you need the money for your renovation all at once.

A home equity line of credit (HELOC) is a good choice if you’ll be paying for your project in stages. With this option, the lender agrees to advance you money up to a specified limit, and you access the money as needed with an ATM card or checkbook, making it easy to pay contractors. Monthly payments can be lower than those of a home equity loan, since you have the option of paying interest only on the money you withdraw. The other important difference is that HELOCs carry adjustable interest rates, while home equity loans typically have fixed rates.

Refinancing your mortgage is an option to consider if you’ve already built some equity in your home and you’re planning a major renovation. For example, if you want to borrow $30,000 to build an addition and you have $120,000 left to pay on a $200,000 mortgage, you may be able to take cash out by raising the principal on your mortgage to $150,000. This would allow you to pay for the entire renovation up front. Depending on the terms, your monthly mortgage payment might remain the same; only the length of the loan will be extended. If you’re adding something structural (as opposed to simply redecorating) lenders may approve you based on the projected value of your home after the project is complete.

FHA 203(k) mortgages allow you to refinance and create a new mortgage at the same time. The loan value will be based on the house post-changes. So you will be able to borrow more and have the option to either hire a contractor or DIY. The drawback is that is limits vary but usually last for 30 years. 

Energy-efficient mortgages (EEMs) have been used for new construction but are now being pushed for current homes as well. An EEM demands your house meet Fannie Mae's energy-efficiency standards.

B and C loans are an option when you don’t have “A” credit offered by banks, credit unions, brokerage houses, and finance companies. Lenders offer them for debt consolidation with good introductory rates. However, interest and fees tend to be high because of the risk they take on for you. Plus the loans lack consistent terms, so it’s hard to know which is better for you. 

A personal loan or line of credit may be all you need for a smaller project. The fees to set these up can be lower than those for refinancing your mortgage or tapping your home’s equity. The drawbacks? Personal loans are not secured with your home, so they carry a higher interest rate. But depending on the rate, they may still be more favorable than using a credit card. In addition, interest on your mortgage or home equity loan may be tax deductible whereas interest on a personal loan is not. Always consult a tax advisor about your particular situation.

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