You love your neighborhood and everything about where you live, but you wish you could make some changes to your home.
You’re not alone with this thinking. But many homeowners don’t move forward since they believe that financing and lack of cash is a roadblock for them when it comes to renovating their current home.
Below are four financing options that can help you make that renovation come true!
Remember to always meet with a financial advisor and perhaps also a tax advisor before you pursue anything. There are pros and cons that you need to fully understand based on your specific financial situation.
Before you learn more about the details of HOW to finance your renovation, it’s very important to decide on the amount of money you can spend on your renovation.
Please be cautious not to over-improve your home for the neighborhood or spend your renovation dollars on details that won’t provide “return on investment” when you resell.
(Not sure what that really means? Always feel free to call me so we can review what you are thinking about doing for your renovation.)
Pros and Cons for Each Finance Option
1. Tap Your Home’s Equity
A home equity loan with a second mortgage allows you to take a loan that’s based on your home’s equity plus other factors such as your income.
Remember, the equity in your home is basically the difference in the home’s current market value and the balance left on your mortgage.
Pro: Once approved, you get an upfront lump sum and must repay a certain amount each month subject to a fixed interest rate. It will be a fixed monthly payment, just like a first mortgage. The length of the loan is shorter than first mortgages, usually five to fifteen years.
This second mortgage can be a great way to tap into your equity and use it to improve your home’s value. It’s a viable option for those of you who have a low interest rate on your first mortgage and don’t want to do a cash-out refinance on that first mortgage (see #4 below).
The interest is tax deductible, but check with your tax advisor, of course.
If your current interest rate is low on your first mortgage, then you can keep that mortgage if rates have increased. This new second mortgage would be a completely separate mortgage from your current one.
Con: Typically that second loan’s interest rate is slightly higher than the market interest rates available. You’ve also now added an additional monthly mortgage payment.
If you can’t pay back the loan, you risk losing your home. Also, you must pay back the loan in full when you move or you’ll need to get a new loan to pay back this loan.
2. Home Equity Line of Credit (HELOC)
With a “line of credit,” you are approved for a certain credit limit based on your home’s equity, just like the second mortgage option explained above.
The difference is that this loan functions almost like a credit card — you can withdraw money when you need it over the lifetime of the loan, such as 10 years. You can take out money as needed and pay back only what you’ve taken out.
Your payments change based on how much of a loan you’ve taken out as well as what the interest rate is that month.
Pro: You only pay interest on the amount you withdraw and not on the total amount approved. Interest rates are usually lower than credit cards, and payments are tax deductible.
This is a great option for folks who are going to be able to pay off the line of credit with an upcoming bonus or sale of another home.
Just like the second mortgage, you can leave your current mortgage alone at a low interest rate if you have one. No need to mess with a good thing, this HELOC would be an additional loan and seen as short term because of the variable rates.
This is a great option if you can pay off the amount you borrow pretty quickly either through selling another property, an upcoming increase in income or an upcoming bonus.
Con: Credit lines have variable interest rates rather than fixed rates so your repayments can change depending on the interest rate at the time you withdraw money.
You should carefully review all requirements, fees, penalties and how often the interest rate is adjusted since HELOCs can vary depending on the lender.
3. Renovation Financing Loan
If you don’t have much equity in your home, you can consider a renovation loan. The lender bases the loan on what your home will be worth once the renovation is complete.
For this loan, you refinance your current home and add on the amount needed for the renovation to the same loan. So it’s one large loan, not a second mortgage.
This loan requires that you work with a contractor and architect and not do any DIY work. Rather than getting a lump sum directly to you, the lender is the one who pays the contractor as the work is done.
Pro: You don’t need equity in your home now because the loan is based on the value of the home once the renovation is complete.
Monthly payments on these loans are typically lower than credit cards or personal loans. And the interest is tax deductible.
Con: Your mortgage balance will increase since you are refinancing with a larger amount. The lender has more say over the timeline and process of the renovation. This money is only used for a renovation with a contractor, who the bank pays directly.
4. Cash Out Refinancing
This financing is similar to a renovation financing, but lenders base the loan on what the home is worth now, not when the renovation is completed. So you’ll need equity in your home.
For this loan, your original mortgage loan is paid off and the amount needed for the renovation is rolled over into the new mortgage total.
This can be a good option if interest rates have gone down recently. You’ll be able to take advantage of lowering your interest rate while at the same time tapping into the equity of your home for the renovation. It’s like a “two-for-one special” of the loan world.
Just make sure interest rates are lower than your original loan. If not, it may make more financial sense to do one of the other options.
Pro: The amount needed for the renovation is given directly to you in one cash payment rather than having the lender pay the contractor. You have more flexibility with this financing.
Con: Keep an eye out for interest rates so you don’t get a higher one than you have now.
Choose Carefully for Your Situation
Remember to choose a financing option that works well for you in both the short and long-term, weigh the pros and cons of all viable options for your situation.
Having the ability to stay in your current home and neighborhood with a renovation can be a huge plus for many homeowners. But just be aware of the time, energy and possible displacement that living through a renovation entails before you move forward and start the process.
Always feel free to reach out to me. I’m here to help you with any real estate–related questions, even if you aren’t buying or selling anytime soon. I can help you determine what renovations would be good investments, and which you might not get your money back on if you plan to resell over the next few years.
I’m also happy to review any of the loan options you’ve been provided to help you compare the options and make sure you are getting the most band for your renovation buck!
Last, but not least, I have great lender resources who can help you with the financing options I’ve mentioned above.
I'm Mike and I love helping buyers discover what's really important in their forever home, then working to find that in Chicago's
Northwest Suburbs. I also have a soft spot in my heart for teachers and love giving back to them whenever I can. Let me know how I can help you make your real estate dreams come true.
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