Home > Mortgages > Planning a Remodel? Your Loan Options

Comments 0 Comments

Home equity has reappeared as an option for many homeowners; as such, remodeling projects have a green light. Maybe you’re thinking about renovating the kitchen, adding on a bathroom, how about replacing the roof? All of these and other improvements tend to be costly. So what’s the best way to finance these projects? Here’s a quick breakdown to selecting the right remodeling vehicle for you, from the lowest cost to highest cost options.

Home Equity Line of Credit (HELOC)

A HELOC is akin to a large credit card limit, and in a sense, it’s used in the same way. You have the ability to borrow on a certain percentage of the line amount and typically have to pay that back in a term of 10 years, with the first 10 years based on an interest-only monthly payment.

From a cash flow perspective, the program is quite favorable because the monthly payment tends to be quite low. How it works is the equity line is tied to the prime rate plus a margin (the mortgage lender’s profit). The margin can be anywhere from 0.5% to 3% and higher in some cases depending on the loan-to-value ratio and your credit score. Typical equity lines are offered a prime +0.5 or prime +1. So you’re talking about a 3.75% equity line of credit that would be secured against your home — either in first position if you don’t already have a first mortgage, or in second position if you do have a first mortgage.

Pros

  • Extremely cheap right now, as long as interest rates remain favorable;
  • Takes 30 days or less to obtain;
  • Typically goes up to 80% loan-to-value, or combined loan-to-value if there is already a first mortgage on the property;
  • Payments are based on interest-only so if you make a larger payment towards principal, it will be reflected in the following month’s payment.

Cons

  • This is not a long-term solution in the sense that an equity line of credit is an adjustable-rate mortgage. It’s tied to the prime rate, which moves in lockstep with the Fed’s stance on monetary policy. When the Fed tightens credit, short-term rates rise, as well the rate and payment on the HELOC.
  • The payment is interest-only every month, meaning unless you make an extra principal prepayment, none of the monthly payment goes toward paying down the principal balance.
  • If you have a first mortgage that you want to refinance, the second lien holder with the equity line of credit will have to agree to subordinate to a new first mortgage. In other words, they will have to agree to stay in second position, which could derail the deal on refinancing your first.
  • For a second lender holding a HELOC, they will almost always charge a fee to consider re-subordinating to a new first loan.

Cashing Out a Mortgage

This option essentially involves taking out a first mortgage to pay off the current mortgage and any subsequent second mortgages in addition to borrowing enough to cover the cost of the remodeling project. To complete a cash-out refinance, most lenders require a loan-to-value of 75% and a high credit score in the neighborhood of 700 or better. Whether the new first mortgage contains a term of 30 years or 15 years, the idea would be taking on a house payment that would allow you finance the total cost of the remodeling project.

Pros

  • Longer-term lower cost of funds using a fixed-rate loan;
  • Takes 30 days or less to obtain;
  • Goes up to 75% loan-to-value;
  • Principal balance is reduced monthly by virtue of timely payments of principal and interest on an amortizing fixed rate.

Cons

  • Interest rate could be higher than current first mortgage rate;
  • May need to finance more than the cost of the project, thus paying interest on money not needed;
  • May not be able to get as much cash out due to 75% maximum loan-to-value.

Personal Loan

This type of loan can be obtained from a local bank or even from an online lender. Rates are anywhere from 6% to 7% with excellent credit working with a peer-to-peer online lender, and upwards of 11% if you’re working with a local bank or credit union. These loans have shorter terms because they are unsecured, and lenders want to be paid back faster. The reduced loan terms creates a higher payment, making a personal loan pricier in the shorter term.

Pros

  • No loan-to-value is required;
  • Can be paid off sooner than traditional financing;
  • Faster access to procuring funds.

Cons

  • No tax advantage;
  • Substantially higher rates compared to refinancing a first mortgage or obtaining a HELOC;
  • Higher payments on these loan types must be counted into debt-to-income ratios on future loan transactions, limiting your ability to qualify.

Because home improvement project costs, especially larger-scale construction — such as an addition of a bedroom or remodeling of the bathroom — tend to vary, it’s always ideal to try to get more funds than necessary to account for variances that inevitably arise. With all of the three financing types laid out, if the additional funds are not needed, they can be reinvested back into the principal balance of the debt. However, of the three loan options, this approach would only reduce the HELOC payments. The other two options are based on principal and interest amortizing loans where the payment would remain constant, despite the additional principal reduction.

As you’re considering your loan options, it’s always a good idea to be informed and know what your credit score is, so you know approximately what kind of rate you’ll get. You might find that you want to take more time to build your credit in order to get a better rate on your loan.  There are free online tools that allow you to check your credit score, such as Credit.com’s Credit Report Card, which also gives you a breakdown of your credit profile to show you what areas you need to work on in order to get a better credit score.

Image: iStock

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Certain credit cards and other financial products mentioned in this and other articles on Credit.com News & Advice may also be offered through Credit.com product pages, and Credit.com will be compensated if our users apply for and ultimately sign up for any of these cards or products. However, this relationship does not result in any preferential editorial treatment.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.

Our Owners

Credit.com is owned by Progrexion Holdings Inc. which is the owner and administrator of a number of business related to credit and credit repair, including CreditRepair.com, and eFolks. In addition, Progrexion also provides services to Lexington Law Firm as a third party provider. Despite being owned by Progrexion, it is not the role of the Credit.com editorial team to advocate the use of the company’s other services. In articles, reporters may mention credit repair as an option, for example, but we’ll also be sure to note the various alternatives to that service. Furthermore, you may see ads for credit repair services on Credit.com, but the editorial team isn’t responsible for the creation or implementation of those ads, anymore than reporters for the New York Times or Washington Post are responsible for the ads on their sites.

Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team