If you own a home, there will likely come a time when you consider some type of remodel or renovation. Home renovations can be a great way to increase the value of your home, update to a more modern look, create more space, or change the function of a room.
While home renovations will likely boost your home's resale value when you are ready to sell, they can be costly. This makes determining the right way to pay for renovations an essential part of the planning process.
Here are some tips to consider:
Major vs. Minor Renovations
If you are considering simple renovations such as replacing light fixtures, updating cabinets, or redoing flooring, you may be able to utilize your savings to pay for the project or you might consider taking out a small loan. If you’re looking to complete more complicated and costly renovations however, such as removing or adding walls, building a garage, or completely remodeling a bathroom or kitchen, you may need to consider longer term financing.
Financing Options to Consider
Once you determine exactly what you’ll be renovating, you should determine the amount of financing you will need. You will also want to consider whether you will need the funds all at once, or if you’ll be paying for the renovation project over time. You should also determine how much you can afford to pay in monthly loan payments, and what your ideal timeframe is for paying back the borrowed funds. Review your current financial situation and credit history to see how they will affect your borrowing power.
Below are some possible options for financing home renovations:
Home Equity Line of Credit
A home equity line of credit, or HELOC, is one of the most popular options for financing extensive home renovations. It allows you to tap into the equity you currently have in your home. With a HELOC, you are given a credit limit and you can draw funds from the account for a specified period of time. The amount of credit you can qualify for will be based in part on the value of your home, determined by a home appraisal.
With a home equity line of credit, you can withdraw funds as often as you need to during the account’s “draw period”, which is typically between 5 and 10 years. A HELOC is like a credit card in that it is a revolving line of credit. In other words, as you pay back your balance, that credit becomes available again. You also only pay interest on the funds you use. So even if you have a $100,000 line of credit, you’ll only pay interest on the amounts you withdraw.
HELOCs typically have a variable interest rate, meaning that it can fluctuate over time. In some cases, a HELOC may have a special “introductory rate” for a fixed period, before the rate starts to fluctuate.
Before considering a HELOC, it’s important to understand that your house is used to guarantee the loan. With your home on the line as collateral, failure to pay back your HELOC could result in you losing your home.
Home Equity Loans
Another financing option that taps into your home equity is a home equity loan. These loans are sometimes referred to as “second mortgages” and like a HELOC, they allow you to borrow against the value of your home. But unlike a HELOC, where you can withdraw funds over time as needed, a home equity loan provides the borrowed funds to you in one lump sum. You must then repay it based on the terms of the loan. In most cases, a home equity loan has a fixed interest rate for the life of the loan. This means your monthly loan payment will be the same each month.
Like a HELOC, a home equity loan is secured by your home. So, be sure that your budget allows you to easily cover the monthly payment, in addition to any other monthly bills or mortgage payment you may be responsible for.
If interest rates are currently more favorable than when you initially took out your mortgage loan, you may consider a cash-out refinancing. This process involves taking out a new mortgage for more money than you owe on your current one, and taking the difference between your new mortgage balance and your old one out as cash. This essentially allows you to tap into your home’s equity without a home equity loan.
Before deciding on a cash-out refinance, it’s important to first determine whether it makes sense for you. A refinance typically makes sense if it would provide you with a lower interest rate. Refinances are also a popular option when you’re looking to pay off your mortgage faster or replace an adjustable-rate mortgage with a fixed-rate one. It’s also important to keep in mind that there are usually closing costs and fees associated with a cash-out refinance.
Specialized Home Improvement Loans
Depending on what your renovation project is, you may be eligible for special financing. For example, FHA Title 1 Loans are an option for borrowers who are looking to make updates that will improve the livability or usability of their home. These loans do not require you to have equity in your home. If you are a Massachusetts or Rhode Island homeowner looking to upgrade your home heating system, or install energy-efficient windows, you may qualify for a Heat Loan. In some cases, these loans can be used to install or replace home cooling and AC systems as well. If your home renovation involves installing a whole-house generator, you may want to consider a Generator Loan.
Regardless of what kind of home update you’re looking to complete, the type of financing you need will largely depend on your current financial position. Consider what your income and credit history currently look like, and how additional loan payments will impact your budget. Get a sense of how much financing you need, and how long you’ll need to repay it. While home renovations often increase the resale value of your home in the long-run, it is vital that you don’t end up drowning in debt during the short-term.
If you’re a Massachusetts or Rhode Island homeowner and want to talk through your renovation financing options, schedule a consultation with a BankFive home loan expert today.