Many Americans want to remodel their homes but lack the cash in the bank to pay for the remodeling projects so home improvement loans have become popular solutions. So what to do? Well, the credit markets are loosening up quite a bit in the last few years, so you may have more options to finance your renovation than you think. Home improvement loans are considered second mortgage loans, as they are a 2nd lien behind the 1st lien on title to your property.
Below are the top four options for home improvement loans for your latest remodel or rehab:
#1 Home Equity Loan
Other than cash in your savings account, the best way to fund home renovations is by using the equity in the property. When you bought your home, you put a certain amount down at closing, commonly 5% or 10%, or even 20%. Also, your home has likely gone up in value since you bought it. You can tap the built up equity to pay for your home repairs.
For example, if your house is worth $450,000 and you need to still pay $150,000, you have equity of $300,000. Most home improvement lenders will calculate 80% of the value of the house, minus what you owe to determine what you may borrow. In this case, you would be able to borrow as much as $210,000.
If you have a high level of equity, a second mortgage or home equity loan can be a very effective way to make expensive home improvements that will add to your home’s value. If you have hundreds of thousands of dollars available, you could get a lump sum amount that is enough to complete a major remodel.
Generally, the benefit of using your home’s equity is that you will get a lower interest rate than you would on virtually any other type of loan. Your loan is backed by the home. If you do not pay, you will lose the home. The lender knows that people will pay their home loan to keep their home, so they are willing to lower the interest rate you are charged.
With a home equity loan, you may find advertised interest rates in the range of 5% or 6% as of 2017. The rate is fixed as well, so you know exactly what you will be paying for years in the future.
Home equity loans are a good option if you have high equity and you need one, big loan for a home project. It also is right for you if you feel more secure with a fixed rate, even if it is higher than other options. In some cases borrowers may opt to get a cash out refinance versus a home equity loan, especially if their first mortgage rate is above the current market level.
#2 Home Equity Line of Credit AKA- HELOC
A Home equity credit line is similar to a home equity loan, in that you are borrowing equity in your home to pay for renovations. There are some key differences, however.
A home equity line of credit is very similar to a credit line on a credit card, but is backed by your home. You can tap the funds on your line of credit as often as you like, as long as you stay under the approved amount.
A HELOCs are a good choice if you are doing a long term home rehab and you are not totally sure how much you need and when.
An equity line of credit has lower fees than a home equity loan, and you do not need to take out all the money at once and start paying interest on the full amount.
Both home equity lines and home equity loans also have interest that is usually tax deductible for most borrowers.
The biggest downside to a home improvement line of credit is the variable interest rate. Your rate can go up, at least after a short, locked period. The rate can only go up so much (check your loan paperwork), but the maximum rate is quite high, in the worst case situation. So, if the worst happens and you do not plan well, you can end up with serious financial problems that can cost you your home.
Some equity lines of credit feature an interest only payment period when you are drawing out the funds. After that, the draw period ends and you begin to pay back interest and principal. This will definitely cause the payment to rise, and you also could have it rise due to a rise in rates.
Both a HELOC and a home equity loan are good choices for your remodel. Which you choose depends upon your personality and your project needs. Either way, you will be getting a loan that at least in theory will add to the value of your home, if you spend the money wisely. It makes sense to review rates and offers from second mortgage lenders that are licensed to service your area.
#3 Personal Home Improvement Loan
Your other major option if you have no equity is a home improvement loan. This is just a personal loan that you use for a home improvement project. Most of these loans offer a fixed rate that you pay off from three to five years.
Most personal home improvement loans are secured by your home or other assets, via private money.
When you take out the loan, you will pay an origination fee of up to 5% of the loan amount, but you don’t have closing costs normally. The major downside of these home improvement loans is that the approval amounts are rarely more than $20,000 or $30,000. This is not enough if you have a major project in mind.
#4 FHA 203K Loan
You can get a streamlined 203k loan for amounts that are no more than $35,000. Or, you can opt for a standard 203k loan that is for larger projects. Both loan types offer you very low rates that allow you to pay back the loan over the life of the entire mortgage loan.
The Bottom Line
If you need to have home improvements done and don’t have all of the cash, you should strongly consider using one of the above four options. You will be able to complete your home improvement so that you can enjoy home more, and hopefully add to your home’s value, too.