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Updated on Tuesday, January 22, 2019
Have you decided to renovate your home? Maybe you want to build an addition, replace a roof that’s long past its prime, or add a deck to spruce up your backyard. These improvements could raise the value of your home while making your living there more enjoyable.But if you don’t have enough cash saved up to fund the project out-of-pocket, there are certain questions you should ask yourself before you begin your project:
What are my goals?
Figure out whether you’re renovating your home for your personal enjoyment or because you are interested in selling. If your goal is to sell, take the time to understand what types of upgrades the average buyer in your area is looking for. You may find that converting your garage into a playroom turns off rather than attracts buyers.
How much do I need to borrow?
The reality is that most home improvement projects are expensive. If you don’t have the cash to pay for your entire renovation, your job will be to determine how much you’ll need to borrow. Consider getting quotes from at least three different contractors so you can get an idea of how much your project will cost.
How’s my credit?
If you hope to take out a loan or line of credit to fund your home renovation, understand that your credit score will play a vital role in how much you’ll be approved for. If you have a poor credit score, it may make sense to put your project on hold until you increase it. A higher credit score can lower the cost of the interest you’ll pay on a loan. That may make it worthwhile to wait to begin your project.
Keep reading to learn about the various ways you can finance your home renovation and improve the condition and value of your home.
What are my financing options?
As soon as you’ve taken time to answer the questions listed above and are clear on the goals of your project, you can begin to think about which financing option is ideal for your budget and lifestyle needs. Let’s dive deeper into the numerous options available.
“Personal loans are a nice option for small projects like modest paint jobs, a little drywall repair, or vinyl flooring for a small space,” said Justin Pritchard, certified financial planner and founder of Approach Financial, Inc., in Montrose, Colo. “Those loans might not have origination fees, so funding is relatively inexpensive.”
Since you can usually prepay personal loans at any time, going this route can reduce borrowing costs. If you believe you can repay your loan within three to five years, a personal loan may be a good idea. However, if you think your repayment will take longer, avoid personal loans. Their interest rates tend to be lower than what you’d pay on a credit card, but higher than on some of the following loans.
Home equity loans
Home equity loans may make sense for larger projects. “The major advantage of a home equity loan is that it almost always comes with a lower interest rate and also has interest deductibility up to $100,000 when the money is used on the house,” said Tendayi Kapfidze, chief economist at LendingTree, which owns MagnifyMoney.
But Pritchard warned that home equity loans can be a double-edged sword. You can borrow a significant amount against your home, so you’ll have plenty of money for major projects. Just make sure that doesn’t tempt you to borrow more than you can afford.
Home equity line of credit (HELOC)
Similar to home equity loans, a HELOC gives you the chance to borrow based on your home’s equity. The difference, however, is that instead of taking a lump sum, you’ll be able to leave the credit line open until you need it. This means you’ll pay for various renovation expenses as they emerge, like you would with a credit card.
HELOCs have variable interest rates, which may cause your payments to change over time. They are based on benchmark rates, like the federal funds rate, plus a margin, which the lender establishes.
A cash-out refinance involves getting a brand new mortgage for all of your housing debt — and then some. Unfortunately, that means restarting the clock on your loan’s amortization process. “At the beginning of a loan is when you pay the most interest, so you need to be careful, especially if you’ve been paying down a home loan for a while,” explained Pritchard. Keep in mind that this method of financing is only an option if you have at least 80% equity in your home.
FHA 203(k) loan
There are a number of loans guaranteed by the Federal Housing Authority, including two types of home rehab loans. The Limited 203(k) allows you to borrow up to $35,000 for minor renovations that are not structural in nature. If you have a repair that may cost more than $35,000 and involves structural improvement, the Standard 203(k) may be your best bet. The estimated value of your home after renovation will determine how much you’ll be approved for.
FHA Title 1
The goal of FHA Title 1 loans is to assist low to moderate income borrowers who are not eligible for traditional home equity loans with home renovations. It is a fixed rate loan that may be right for you if your renovation is intended to“substantially protect or improve the basic livability or utility of the property,” according to the Department of Housing and Urban Development, FHA’s parent organization.
FHA Energy Efficient Mortgage
The FHA Energy Efficient Mortgage may meet your needs if you’d like to put an end to overpaying on utility bills. It can help you save money on your utilities by financing home renovations that are intended to improve the energy efficiency in your home. To qualify for this program, your improvements must be considered cost-effective. The cost of them must be equal to or less than the money you save on energy bills from the improvements.
The Fannie Mae Homestyle® Renovation Mortgage
Fannie Mae’s Homestyle® Renovation Mortgage can give you the chance to finance your renovation when you purchase your home or refinance. That means you can bundle your mortgage and repair costs into one loan with one payment.
You’ll work with a conventional lender, so you’ll need to be able to meet the credit and income requirements of a traditional mortgage. There are other downsides, too: “It is important to keep in mind that this option involves a great deal of paperwork and requires you to work with certain contractors,” said Pritchard.
You may go this route if you love the land on a certain home but can only cover the down payment and closing costs, not the cost of the repairs.
Credit cards and money from savings
If you do not qualify for many loans or funding programs, you may consider paying for your renovation through credit cards and/or money from savings. Credit cards are similar to personal loans in that they aren’t secured to your house. But they generally charge higher interest rates than personal loans do — APRs are in the double digits instead of single digits.
That is, unless you get a credit card that charges 0% interest for a promotional period of time. Some of these cards give you nearly two years before they start charging interest. But you’ll want to make sure you can pay off your balance within that period because the interest rate may be very high after that.
In the event your home renovation can wait, opening up a high-interest savings account and setting aside money on a regular basis until you have enough to fund your project may be your best bet.
“I wouldn’t blow out your emergency fund for home improvements unless it’s a home-related emergency, but if you can cash-flow a project, that’s a great way to go,” explained Pritchard. “The nice thing about that approach is that you can do whatever you feel like paying for now, take a break, and do more as the money becomes available.”
The ideal way to finance your home renovation is dependent on your personal circumstances. While a personal loan may be a good choice for one person, it may be the wrong route for another.
Treat your home renovation as an important investment and evaluate all of your options before coming to a financing decision. By doing so, you can avoid headaches, stress and financial consequences down the road.
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