Most people don’t have enough cash sitting around to pay for a major home addition or remodel — although that’s probably the best way to finance such a project — so they need to study the options available in home renovation loans.
With all the lenders offering so many possible ways to borrow money, the options can be overwhelming. Here are some basic choices. You’ll need to look at your own situation and see which option fits best.
The factors that will affect the route you choose include how much money you need for the project, how much equity you have in your home, how good your credit rating is, how high your income is, how quickly you’ll need the money, and how simple you want the process to be.
Refinance your home and take out cash for your renovation. This works if it makes sense to refinance your home anyway to take advantage of interest rates that are lower than what you’re paying and if your home is worth substantially more now than what you still owe on it. For example, if you owe $250,000 on a home worth $450,000, you could take out a loan for $350,000, replacing the original loan and getting back $100,000 (minus fees) at closing.
The cash-out refinance can give you access to larger amounts of money than other loan options, and it has a fixed interest rate that you can count on. However, these loans come with closing costs that can be significant, and the application process takes time and lots of paperwork, like a first mortgage.
These loans, which can be called second mortgages, use your house as collateral. You will need to have built up equity in your home against which to borrow. Lenders usually limit the amount you can borrow to 80 percent of your home’s appraised value, minus the amount you still owe on your mortgage. So, for example, if your house is worth $450,000, and you owe $300,000, you can borrow up to $60,000. Home-equity loans typically have five-year to 15-year terms, although longer terms are available. They work well when you need all the money at one time.
Home-equity loans usually close relatively quickly, have fixed interest rates, and have lower closing costs than cash-out refinancing. But the rates are higher than refinancing, and the amounts available might not be large enough to cover a major remodel.
Home-Equity Line of Credit
A home-equity line of credit works something like a credit card, using your home as collateral. Your lender will give you a borrowing limit, and you can take out money as you need it for your projects. As you pay off some of your debt, your available credit rises, and you can dip into it again. Some lines of credit require you to pay only on the interest in the first phase of the loan, and then in the second phase, you no longer can draw from the line and must pay off the interest and principal before the term expires. These loans are helpful when you don’t need a lump sum all at once but will be requiring money at intervals over a longer period.
Home-equity lines of credit have adjustable interest rates, usually tied to the prime rate, and they have low or no closing costs. Variable interest rates are attractive at first, but there’s no guarantee they won’t rise. Also, some lenders require an initial draw from the line of credit at closing, so read the fine print.