When it comes to paying for a renovation project, you have options.
Q: How do most people finance a remodel?
A: Owners finance home-remodeling projects in many ways, from using savings to borrowing from a 401k to bank loans. Here are some of the most common avenues to pay for your dream remodel.
1. Cash-out refinance
Most banks will be willing to lend you up to 80 percent of your home’s value, minus whatever you still owe on your mortgage.
Pros: You get a lump sum and don’t have to deal with complicated draws. It’s a chance to lower your interest rate. The interest you pay may be tax deductible.
Cons: You will usually have to pay closing costs, typically a few thousand dollars.
2. Home equity line of credit (HELOC)
A HELOC allows you to keep your original mortgage. During the draw period, you will make interest-only payments. This is followed by the repayment period (typically 10 to 15 years).
Pros: A HELOC allows you to borrow only what you need. Unlike a cash-out refi, you only owe interest on the amount you’ve borrowed to date. You may not have to pay closing costs.
Cons: When your repayment period begins, the higher monthly payments may take you by surprise. Interest rates may be variable.
3. Home equity loan
This is another type of loan that is secured against your home. Instead of a line of credit, you will be borrowing a fixed amount as a lump sum.
Pros: You can keep your original mortgage, which may be beneficial if it has a very low interest rate. Interest payments may be tax deductible. You don’t have to deal with a complicated draw schedule.
Cons: You will begin owing interest on the entire amount from day one.
4. Remodeling construction loan
If you are making major renovations and do not have enough equity in your home to pay for them, you may want to explore a construction loan.
Pros: It extends your borrowing potential. The bank will appraise the house based on its future value after the remodel is complete. You can often qualify for a low fixed interest rate, and most or all the interest will be tax deductible.
Cons: Refinancing may not be desirable if you currently have a low fixed rate. Your building plans must be finalized before you can be approved. You may have to refinance into a permanent loan when construction is complete.
5. FHA 203k loan
These loans are backed by the Federal Housing Administration. They could be a good option if you have found a home you want to purchase that needs major repairs.
Pros: Down payments as low as 3.5 percent and relatively low interest rates are the main benefits. You can borrow up to 110 percent of the home’s projected value after repairs.
Cons: A lot of paperwork. You are required to address any health and safety issues with your home.
6. Borrow from your 401(k)
Tapping your retirement account gets a lot of bad press, but it may be a decent option in certain circumstances.
Pros: Your interest rate can be lower than that of a personal loan (typically around 5 percent). The approval process is quick and won’t show up on your credit report.
Cons: You are limited to $50,000, and the repayment schedule is quicker than for some other types of loans.
7. Reverse mortgage
If you are age 62 or older and have equity in your home, you may qualify. This loan is similar to a HELOC, but you don’t make payments during your lifetime.
Pros: It is a way to access the equity in your home. No payments will be due during your lifetime.
Cons: It will diminish the value of your estate, leaving fewer assets for your heirs. Fees may be higher than with a traditional mortgage.
There are many options available to you as a homeowner seeking to fund a remodel. It may be worth exploring several options to determine what’s best for you. Start a conversation with your banker or broker at the same time you start exploring remodeling options. Knowing from the start what funds you have available to you will help make the design process smoother and allow you to avoid surprises down the road.
Denny Conner is the president of CRD Design Build and a member of the Master Builders Association of King and Snohomish Counties (MBAKS). If you have a home improvement, remodeling or residential homebuilding question you’d like answered by one of the MBAKS’s nearly 3,000 members, write to firstname.lastname@example.org.