How Will I Pay For My Remodel?
Let’s talk about how you’re going to finance that remodel.
Ready for your dream kitchen? Or basement remodel? Or perhaps a new master suite with a new bathroom?
I know I know, typically, people don’t like to talk about money. But when you embark on a major remodel of your home, the sooner you know your options, the smoother the process will go.
More and more, people are choosing to remodel their house to fit their lifestyle vs leaving their neighborhood and finding a new home. But if you’re like most people, you’re not sitting on a huge pile of cash to create your dream space. And it turns out, remodeling can be expensive.
So where do you start?
Homeowners have options when it comes to financing a remodel. Home equity lines of credit, home equity loans, cash-out refinances, construction loans, and personal loans are just some.
We’ve found that most of White Crane’s clients utilize the following.
Home equity line of credit (HELOC)
Home equity loan (HEL) – or second mortgage
Cash out-out refinance
Your lender may explore other solutions with you based on your financial situation, but it’s good to have some background about these options. They’ll also walk through the different costs associated with each option.
For the first three options, let’s look at how lenders typically determine the amount you can borrow. To begin, they’ll look at the amount of equity you have in your house to determine the max loan amount. In many cases, they’ll order an appraisal to determine your home’s value. Typically, the amount you can borrow will be around 80-85% of the equity of your home. This is referred to as the Loan to Value Ratio. For example, if your home is appraised at $200K, and you owe $100K, the amount you could borrow is typically in the $80K-$85K range (80-85% of your $100K equity). This final number can vary based on your income, credit score, and other factors unique to each homeowner.
Here’s a deeper look into each option.
1. Home Equity Line of Credit (HELOC)
A HELOC works much like a credit card. Once your lender has determined the max amount you can borrow, you’ll be able to draw money out of the HELOC when you need it, up to your max allowance. Your minimum monthly payment will be the interest accrued each month. One advantage of a HELOC is that the interest accrued is a tax write off when the money is used for home improvements. One disadvantage is that the interest rate is variable (meaning it can change month to month in some cases).
2. Home Equity Loan (HEL), or second mortgage
Lenders offer different types of second mortgages with unique terms. The primary difference from a HELOC is that this loan amount is a lump sum given to the homeowner, with a fixed interest rate. This means that after closing, you will start making loan payments based on the terms of the loan. Similar to the HELOC, the interest should be a tax write off.
3. Cash-Out Refinance
If your current mortgage is at a high-interest rate, or you’re looking for a lower monthly payment after you remodel, a Cash-Out Refinance may be a good option. Basically, a Cash-Out Refinance looks at the equity in your home and rolls everything into one new loan with a fixed payment, using that equity to fund the remodel. One thing to keep in mind with this solution is your loan terms will be reset. For example, to keep your overall payments low, you may decide on a new 30-year cash-out refinance even though you only owe 10 years on your current mortgage.
4. Construction Loan
This type of loan is unique as it looks at the value of your home after the remodel is completed. To figure this out, your lender will do an appraisal on the finalized plans from your designer, and base the loan value both the future-value and equity available in your home. It’s important to note that not all lenders offer construction loans as they require more involvement from the lender throughout the construction phase.
There’s a great tool on nerdwallet.com that asks a few quick questions, and immediately gives you an idea of what may be a good financing option for your situation. Take a look (https://www.nerdwallet.com/mortgages/home-improvement-financing-alternatives)
Everyone’s situation (and lender) is a little different, so be sure to talk to your lender about options for financing.