Improving or updating your home – whether it is an addition, updating a kitchen or bath, or finishing the basement – improves your quality of life and increases the resale value of your home. These kinds of projects can cost tens of thousands of dollars, but there are several financing options available. To choose wisely you need to consider several factors:
- how much you need to borrow.
- how much equity you currently have in your home.
- how much value your project will add to your home.
- whether you need the money all at once or would prefer to draw on it as necessary.
- whether you want to make amortized payments or follow a more flexible schedule.
- your comfort level with placing a second mortgage on your home.
Your first steps should be to get pre-approved by a lender to determine how much you can spend, and to get an estimate from a qualified contractor to determine if your project is feasible with the financing that is available to you. Then here are your financing options:
A home equity loan
Works much like a conventional mortgage. You borrow a lump sum that is secured against your home, and is repaid over several years. Usually, the interest rate and monthly payment usually remain fixed throughout the term of the loan. This option requires an additional payment on top of your first mortgage and usually carries a higher interest rate than refinancing your mortgage. However, the closing costs may be lower and it can be right if you prefer not to refinance and you need the money for your renovation all at once.
A home equity line of credit
A HELOC is a good choice if you will need to pay for your project in stages. In this case, the lender agrees to advance you money up to a specified limit, and you access the money as needed with an ATM card or checking account, making it easy to pay contractors. Monthly payments can be lower than those of a home equity loan, since you have the option of paying interest only on the money you withdraw. The other important difference is that HELOCs carry adjustable interest rates, while home equity loans typically have fixed rates.
Refinancing your mortgage
An option to consider if you already have equity in your home and you are planning a major renovation. For example, if you want to borrow $45,000 to build an addition and you have $120,000 left to pay on a $200,000 mortgage, you may be able to take cash out by raising the principal on your mortgage to $195,000. This would allow you to pay for the entire renovation up front. Depending on the terms, your monthly mortgage payment might remain the same; only the length of the loan will be extended. If your project will be an addition (as opposed to simply redecorating) lenders may approve you based on the projected value of your home after the project is complete.
A personal loan or line of credit
May be all you need for a smaller project. The fees to set these up can be lower than those for refinancing your mortgage or your equity. The drawbacks? Personal loans are not secured with your home, so they carry a higher interest rate. But depending on the rate, they are usually more economical than using a credit card. However, interest on your mortgage or home equity loan may be tax deductible whereas interest on a personal loan is not.