Making improvements to your home can be extremely costly. In this article, we consider your borrowing options with information and advice about:
- What to consider before making changes to your home
- Your home improvement borrowing options
- Alternative ways to pay for home improvements
- The benefits of prequalification
Many home owners are interested in renovating their property – to update old-fashioned fittings for the sake of convenience and/or to add to the value of their property. However, very few have the cash to pay for the necessary changes. Before we weigh up your borrowing options and their pros and cons, we tell you what factors to consider before borrowing money. We conclude this article by looking at other ways to pay for necessary renovation and maintenance work.
What to consider before making changes to your home
Before working out the financial aspect, you should think about how necessary the remodeling work is. Although many home owners believe that fixing up their property will automatically add to its re-sell value, this doesn’t necessarily mean that they will recoup their cash lay-out. Adding a second story or a deck won’t add the same value to their home (as a proportion of its cost) as structural work like replacing the roof or the vinyl siding.
Another factor to bear in mind is your long-term plans. Renovation work makes good sense if you’re planning to stay in the property long term. However, if you’re planning to re-sell in a few years, some borrowing options can significantly reduce your equity in the property, and the loan will have to be repaid when the home is sold. This can affect your next home purchase. Also, some lenders prohibit renting out your home if you’ve borrowed against its value to improve it.
Once you’ve decided that home improvements are essential, your next step is to collect estimates to have a ballpark figure of how much it will cost. You must be as accurate as possible as you need to borrow enough to pay for the job to be completed, but not too much as this will cost you more.
Your home improvement borrowing options
You should start looking around for possible borrowing options about 4-6 weeks before you’d like to start work. How to pay for your renovations will primarily depend on how big the project is and how much it will cost.
Unsecured personal loans
If your planned home improvement project is relatively small, your best option might be an unsecured personal loan. These loans have an average term of 2-7 years, and you can usually borrow $1,000-$50,000. The interest you pay can vary widely from 2.5-36% and depends on your overall creditworthiness. Your APR can be much higher than a home equity loan unless you have an excellent credit score and income. Getting prequalified will give you a better idea of how much it will cost you.
One advantage of personal loans is that your equity in the property isn’t taken into account so you’re more likely to qualify for a loan. However, the loan term is much shorter than average home equity loans. Another benefit of unsecured personal loans is that you don’t risk foreclosure.
Home equity loans
On average, home equity loans are much larger than unsecured personal loans, and their terms are much longer (ranging from 5-30 years). The amount that homeowners can borrow chiefly depends on their equity with a loan-to-value limit of around 85%. Apart from considering their equity, factors such as the homeowners’ credit history/income and value of the home will also be taken into account when calculating the interest rate. The interest works out at a little higher than a mortgage. Borrowers must also allow for all the associated fees which are very similar to the ones carried out for the initial mortgage such as an appraisal fee (around $150) and a title search. One benefit is that the interest on these home improvement loans are tax-deductible as long as the combined value of the two mortgages doesn’t exceed $750,000.
Once you’ve decided that home improvements are essential, your next step is to collect estimates to know how much it will cost.
Home equity loans act like a second mortgage on the property. This makes it make less of a risk for lenders, and this is reflected in lower interest rates than other loans. However, the downside is that there’s a risk of foreclosure if homeowners default on their repayments. Also, if the loan is still outstanding when the house is sold, borrowers must pay off the loan from the proceeds of the sale which can reduce their equity in the property.
Home equity lines of credit (HELOC)
Home Equity Lines of Credit share many of the characteristics of a home equity loan but are more flexible. The main difference is that the loan isn’t awarded as a lump sum. Instead, borrowers have a line of credit with a set limit so they borrow money as and when they need it. Apart from this flexibility, HELOCs usually have fewer fees than home equity loans although the interest is also tax-deductible.
The main drawback of HELOCs is that, unlike personal and home equity loans, the APR is variable rather than fixed. This can make it difficult for borrowers to budget for their monthly repayments. There’s also the risk that interest rates may rise making the loan more costly than they originally budgeted for. Another disadvantage is that borrowers must handle this line of credit wisely. Once they’ve reached their limit, no other funds are available.
Alternative ways to pay for home improvements
There are other ways to pay for home improvements which aren’t as popular as the loans described above.
If the home improvements are minor ones, you might choose to put the expenses on your credit card. This solution is convenient as you don’t have to go through an application procedure. Therefore, you save time and money for origination fees which can be as high as 1-6% of the sum borrowed. However, the speedy availability of cash is also a drawback because credit card holders might be tempted to spend on home improvements without thinking the matter through.
The major disadvantage of credit cards, however, is the cost of borrowing. Even if your credit card issuer has a generous rewards program, you should think carefully before using this form of borrowing as the APR is so high.
Title 1 government loans
Underwritten by the federal Department of Housing & Urban Development (HUD), Title 1 government loans allow homeowners to improve the livability of a property. The APR of these loans is much lower than other borrowing options. However, loans are capped at $25,000, and there are certain other eligibility criteria. For example, they can’t be used to make luxury upgrades such as adding a pool or spa.
Conclusion – The benefits of prequalification
There are many borrowing options if you wish to upgrade your property. Once you have chosen the best one for your needs, you should spend some time researching the market for the best lender. You should consider their eligibility criteria and the overall fees (the APR) rather than just the advertised rate. Prequalification can help a great deal as it tells you exactly how much the loan will cost you and prevents any damage to your credit score by repeated hard credit pulls because of refusals.