Home renovations and improvements can substantially enhance the value and longevity of your home, however, unless you have the money saved up, or come into a sudden windfall, financing them is far from straightforward.
This is mainly because a lot of the vanity purchases and upgrades homeowners would like to include in their renovation projects don’t necessarily comply with the underwriting guidelines of leading lenders and financial institutions.
Homeowners, however, do have certain options to seamlessly and cost-efficiently fund their home renovation projects. In this article, we will go over each of these options, along with their respective advantages and limitations.
1) Home Equity Line of Credit (HELOC)
An increasingly popular choice that comes with a great deal of flexibility, and is fairly straightforward when it comes to what you can use the funds for. The home equity line of credit is essentially revolving credit that is secured against the equity you have in your house.
If you have at least 15% to 20% personal equity in your house, you can avail of a line of credit against that, and you will only be charged interest for the amount withdrawn, and not the total value of the HELOC. Borrowers can further avail of terms extending between 10 years to 30 years, during which they only have to pay interest on the outstanding balance, and not the principal.
Despite the obvious benefits of this option for home renovations, there are substantial risks, especially pertaining to overspending if borrowers are not careful. There is also the risk of variable rates, which means that the interest rate on outstanding amounts will depend on broader market conditions.
2) FHA 203(K) Government-Backed Mortgage
For homeowners looking to renovate or repair their primary residence, there are a few other options that can beat the FHA 203(K) mortgage. According to loanDepot, a 203(K) loan is a mortgage that is insured by the Federal Housing Administration, resulting in a low risk of default for lenders and financial institutions.
Aimed at supporting lower-income households, and the revitalization of old, beaten-down buildings, this program allows borrowers to receive as much as 110% of the property’s proposed future value, and even considers individuals with poor credit. The loan also covers the cost of temporary housing while the primary residence is under renovation if required.
The only drawback in this regard is that the loan amount is earmarked for only developments that stand to enhance the livability of a property, and not other vanity or luxury elements. The funds are held in an Escrow account and are only released to contractors as and when milestones are completed.
3) Cash-out Refinance
A cash-out refinance essentially replaces an existing home loan with a newer, larger mortgage, and different interest rate. This allows borrowers to pocket the difference between the two mortgages, which can then be used towards renovations, repairs, or other relevant projects.
This was all the rage over the past two years, given the rising property valuations and rock-bottom interest rates, allowing homeowners to capitalize on both ends.
The key drawback of this option is that it comes with substantial additional costs such as appraisal fees, origination fees, taxes, and other closing costs. As a result, this only makes sense when you qualify for significantly lower interest rates, as was seen over the past year.
With the right planning, research, and execution, an extensive renovation project stands to add substantial value to your home, as well as your personal finances. It remains critical to compare your options and weigh the costs and benefits of each before narrowing down to the ideal choice of financing for your project.