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Don’t move when you can improve: home renovation loans

Erik J. Martin
The Mortgage Reports contributor

In this article:

Upgrading with home renovation loans offers a few advantages over selling and moving:

  1. Your family avoids the hassle of packing, moving and unpacking
  2. You save the cost of selling (6 to 10 percent of the property value) and buying (2 to 5 percent)
  3. You can get exactly what you want. No new home can do that

There are several top methods for financing home improvements. One or more might be right for you.

Verify your new rate (Dec 14th, 2018)

Why move? Consider a renovation loan instead

It can be expensive to sell your home and move today. Closing costs can take a big bite. And uprooting your family is always a hassle. Instead, why not stay in place and improve the home you’ve got? This can be less costly and involve less work. But to make this dream happen, you’ll likely need a renovation loan.

Related: Fannie Mae Homestyle vs FHA 203(k) for major renovations

You won’t be alone. Nearly six out of 10 Americans are prepared to put money into home improvement projects in 2018. Many of these homeowners fund these projects out of pocket. But plenty of others will seek financing.

Funding for a renovation can come from many sources. These include a home equity loan, home equity line of credit (HELOC) and cash-out refinance. Other choices include an FHA 203(k) rehabilitation loan, personal loan, and credit cards. Explore your options. Learn what you qualify for. And do the math. The process may be easier than you expect.

Option #1: a home equity loan

A home equity loan (HEL or HELOAN) allows you to borrow against the equity you’ve built up in your home. Your equity is calculated by assessing your home’s value and subtracting the outstanding balance due on your mortgage loan.

Related: How does a home equity loan work?

With a HEL, your home is used as collateral. The interest rate is usually fixed over the loan’s repayment period (term). This can last from five to 30 years. You may be able to borrow up to 100 percent of your home’s value. But you’ll likely have to pay closing costs on this loan.

A HEL “is dispersed as a single payment up front. It’s similar to a second mortgage,” says Bruce Ailion, Realtor and real estate attorney.

“A home equity loan or HELOC may also be tax deductible,” says Doug Leever with Tropical Financial Credit Union. “Check with your CPA or tax advisor to be sure.”

Option #2: a HELOC

A HELOC functions as a line of credit. Like a HEL, it lets you borrow against your home’s equity and use your home as collateral. But with a HELOC, you can withdraw cash, up to a pre-approved spending limit, over a set draw period. Your credit score, income and home’s value will determine your spending limit.

The interest rate isn’t fixed with a HELOC. Instead, it’s a preset variable rate based on current prime rates. The good news is you only pay interest on the amount you borrow. Also, closing costs are minimal, even zero n many cases. You only start to pay it back once you have a balance owed. The term can span from five to over 20 years.

Related: Need money? A 2018 HELOC could be your solution

By the end of the term, “The loan must be paid in full. Or the HELOC can convert to an amortizing loan,” says Ailion. “Note that the lender can be permitted to change the terms over the loan’s life. This can reduce the amount you’re able to borrow if, for instance, your credit goes down.”

Still, “HELOCs offer flexibility. You don’t have to pull money out until you need it. And the credit line is available for up to 10 years,” Leever says.

Option #3: a cash-out refinance

Another way to get money for home upgrades is via a cash-out refi. This involves refinancing your mortgage and take cash out at closing. This also allows you to convert equity into cash. Your new loan is for a greater amount than your existing loan. You get to pocket the difference between the two.

Related: What is cash-out refinancing?

This option is often best if you can reset your loan at a lower interest rate than your current mortgage. You may also be able to adjust the term to a shorter amount. For example, say you had 20 years left on your 30-year loan. You may be able to do a cash-out refi for a lower interest rate at only 15 years.

Compare costs over the life of the loan, including closing costs. As in, cost of the new loan including closing costs and interest until it’s repaid, versus the cost of keeping your current loan for its life and adding in the new loan costs and interest over its life.

Keep in mind that cash-out refinances have higher closing costs, and they apply to the entire loan amount, not just the cash-out. Unless your new rate is significantly lower than the old one, and you’re taking a large amount of cash, a small loan from another source may be cheaper.

Option #4: an FHA 203(k) rehab loan

An FHA 203(k) rehab loan allows eligible borrowers to finance a remodel in a simpler way. This option is available at the time you first purchase or refinance. Your balance due on the home and rehab costs are bundled into one loan. That means you don’t have to apply for two separate loans or pay closing costs twice.

This loan is backed by the federal government. The rate can be fixed or adjustable. Your down payment can be as low as 3.5 percent. You only need a credit score of at least 620. And you don’t need to be a first-time buyer.

Related: 203(k) loan benefits and downsides

But this loan is designed only for older and fixer-upper homes. Your lender has to be FHA-approved. And your renovation costs must be at least $5,000.

Option #5: a personal loan

A personal loan is an unsecured loan. In other words, you don’t have to use your home as collateral. These loans can be obtained much faster than other types.

Related: 4 alternatives to a cash-out refinance

The interest rate can be fixed or variable. But the rate is often much higher than for a home equity-type loan. The better your credit score, the better your chance of getting a lower rate. Also, the payback period is less flexible: often it’s two to five years. And you’ll probably pay closing costs.

Option #6: credit cards

You can always charge some or all of your remodeling costs using plastic. This is the quickest and simplest way to fund your project. After all, no paperwork is involved.

But because rehabs often cost tens of thousands, you need to be approved for a high credit limit. Or, you’ll need to use two or more credit cards. Plus, the interest rates charged by most credit cards are among the highest you’ll pay anywhere.

Related: Can you pay your mortgage with a credit card?

If you must use a credit card to fund your rehab, try this: apply for a card with a zero percent introductory rate. Some cards offer up to 18 months to pay back the balance at that rate. This approach is only worthwhile if you can pay off your debt within that time span.

Shop around

As with anything in life, it pays to assess different loan options. So don’t just settle on the first loan offer you find. Compare loan types, rates and terms carefully.

“Get multiple quotes,” suggests Ailion. “And compare the annual percentage rate (APR). Different lenders may be willing to lend you more than others.”

Verify your new rate (Dec 14th, 2018)