Process Guides / By Carol Wang / May 11, 2016
Options for Financing a Home Renovation
Sweeten translates insight from renovators and contractors into information you can use to make better decisions about improving your home. Here’s a look at options for paying for a major home renovation.
1. Pay in cash
Paying in cash is the most straightforward way to go. If you plan to pay cash (and even if you don’t!), be sure to lay out a clear payment plan with your contractor so there are no surprises.
Most projects require a deposit upfront with installments at various points over the duration of the project. You might see terms on a smaller project for two payments, with 50 percent due upfront and 50 percent due at completion. For a straightforward project like a kitchen or bathroom renovation, you might agree to pay 15 to 30 percent upfront, 40 to 50 percent at the midway point, and the final 15 to 30 percent upon completion. Larger projects tend to require less upfront but more payments along the way. You can expect to peg payments to milestones like demolition, midway project completion, and punch-list completion. Work with your general contractor to agree to these terms and put it all in writing!
Do note that some general contractors will accept credit card payments. Not all contractors will take this form of payment, but it’s worth asking (and think of the points you’ll earn!), as it can help you stretch the payments over the course of a few months.
If you feel confident about your ability to pay on time, you might also look into opening a zero interest credit card. Be aware that these cards typically have very high interest rates that kick in if you don’t pay off the balance by the end of the zero interest period (usually twelve months), but they can be a tool in spreading out payments beyond the duration of the project.
2. Take out a personal or unsecured loan
If you anticipate that your renovation will come in under $50,000, you might consider a personal (or “unsecured”) loan from a credit union, bank, or other lender. These loans do not require collateral (meaning that the loan isn’t tied to your home and won’t jeopardize it if you default) and are usually fairly easy to acquire.
Personal loans offer higher funding amounts than credit cards do, but less than a home loan would provide. These loans tend to be offered for a fixed term at a fixed interest rate and are repaid in monthly installments. The downside, of course, is that the interest rates on these types of loans tend to be much higher than on loans associated with your home (like mortgages with built-in renovation financing, home equity loans, or home equity lines of credit). Expect to pay interest in the range of 6.5 percent on a $50,000 loan over 24 months (by comparison, mortgage rates currently range from about 3.25 percent to 4.125 percent interest for 15 and 30 year fixed terms). Rates tend to vary quite a bit for personal loans, so do your research to see what makes the most sense for your renovation.
3. Build financing into your mortgage
If you are currently in the process of purchasing a home, this might be the way to go. And if you already own but are considering refinancing, this option can help you adjust your mortgage rate and simultaneously roll new financing into it (a process known as “cash-out refinancing”). Either way, you go through both the mortgage and renovation financing application process once and you’ll end up with one monthly payment for both.
Interestingly, the lender you choose will likely calculate the amount of the loan based on the future value of the renovated property. This means that you can borrow more because you may qualify for a larger loan than you might if the calculation were based on the pre-renovation value. This also tends to mean that you don’t have to worry about the current condition of the home; with some other types of financing, the lender may balk if the property is in disarray.
As with regular mortgages, you can choose between a conventional loan and one backed by the Federal Housing Administration (FHA), known as a FHA 203(k) loan. 203(k) loans have more lenient guidelines and allow the homeowner to borrow a higher percentage of the home’s current value. With either a conventional or FHA mortgage, your monthly payments may be lower than they would be with a home equity loan or line of credit (both detailed below). These loans are also attractive because you are locking in your rate so payments will not unexpectedly fluctuate.
Note that built-in loans may have requirements regarding the timing of your renovation, however. They may require that you begin and complete your renovation within a set window after closing, and they may stipulate that work cannot stop for more than a set period of time. So, these loans are not well suited for future renovations or work that might take place at different stages.
4. Take out a home equity loan (HEL)
A home equity loan is often referred to as a “second mortgage,” and is an option if your home is worth more than what you now owe on your mortgage. This type of loan is similar to a conventional mortgage in that it offers tax deductions on interest payments and in that you make payments over the course of a long period of time. Note that there may be closing costs involved, and while the interest is usually fixed, the rates are generally a bit higher than conventional mortgages. In addition, sometimes lenders charge a penalty if you pay off the loan early, so be sure to look closely at the terms.
5. Establish a home equity line of credit (HELOC)
A home equity line of credit is most comparable to a credit card: the lender gives you a credit limit and charges you interest on the amount you use. Instead of receiving a lump sum upfront, you borrow what you want when you want. This makes it a good option for a series of projects, or if you anticipate that your renovation will be lengthy. You can obtain these types of loans from all the usual suspects—banks, finance companies, brokerages, and credit unions.
Interest rates are adjustable, so beware of loans with low initial rates. Some may also have a minimum withdraw, and many offer 5-10 years of access to the credit line. While the credit line is open, you pay interest on what you owe, and then you typically have 10-15 years after it closes to pay it back in full. Compared with home equity loans, a home equity line of credit offers more flexibility, but since the rate fluctuates, it is also riskier. The terms and conditions vary widely on credit lines, interest rates, and fees, so it’s important to read the fine print.
If you’ve financed a renovation project with one of these options, or in an unconventional or particularly resourceful fashion, let us know!
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