Home improvements can cost thousands of dollars. If you don’t have the money lying around, you might wonder just how you’ll get the job done. Credit cards may work, but their interest rates are so high. You are usually better off applying for a home loan for home improvements
Depending on your situation, there are a variety of home loans you can apply for to get your home improvements done.
Home Equity Loan/Line of Credit
One of the most popular methods for home improvements loans in the home equity loan or line of credit. Both options are a second mortgage that is secondary to the first mortgage/lien on your home. Lenders allow you to borrow between 80% and 85% of your home’s equity for home improvements.
You can determine how much you can borrow by determining the current value of your home. Multiply that number by 85%. Then subtract the amount of your outstanding first mortgage balance. The amount that is left is the amount you can borrow for a home equity loan/line of credit.
Now let’s talk about how the home equity loan and line of credit differ:
- A home equity loan is a fixed rate loan. You receive your funds in one lump sum. You then make principal and interest payments for the term of the loan, usually 15 to 20 years. You are not able to reuse the funds once you pay them back. It’s like your first mortgage, just for a smaller amount.
- A home equity line of credit is like a credit card. You get access to an account, usually a checking account with a debit/credit card. This account has your funds in it. You withdraw the funds as you need them for your project. You only have to make interest payments for the first 10 years. The interest you pay is on the money you withdrew. You don’t pay interest on any unused funds. If you do make principal and interest payments, you can reuse any principal you paid back (like a credit card). After the 10-year draw period, you will owe principal and interest payments for the next 20 years and be unable to draw on the funds any longer.
If you have good credit, a decent debt ratio, and room in your equity, you may just refinance your first mortgage. Rather than refinancing it for the amount of the outstanding mortgage, though, you will take a higher loan amount. Most loan programs allow a loan-to-value ratio of up to 80%. You can tap into a little less equity than you could with a home equity loan or line of credit, but you only have one loan to manage.
The cash-out refinance pays off your first mortgage and replaces it with the loan with the higher balance. You make principal and interest payments starting with the first payment. You also receive the funds in one lump sum, allowing you to do with the funds as you see fit.
The interest rates on cash-out refinances are sometimes a little higher than what you might pay on a purchase loan because of the risk the lender takes. If you bought your home during a time when interest rates were inflated, though, this could be a good time to get a lower rate and tap into your home’s equity at the same time.
If you have an FHA loan or even if you don’t, the FHA 203K is a great program that helps you refinance your mortgage and get money to renovate it. The difference with this program is that you can borrow as much as 110% of the after-improved value. This means you borrow more than the home is worth right now or even more than it’s worth when you renovate it.
The lender will rely on the appraiser’s value of the home after considering the renovations you plan to make. The appraiser gives each renovation a dollar value and determines how it affects the home’s final value. While you shouldn’t expect a dollar-for-dollar increase in the home’s value, you may see an increase depending on the type of renovations you have planned.
The FHA 203K is one loan. The new lender will pay off your current first mortgage and then put the remaining funds in an escrow account. The lender is in charge of distributing the funds.
There are actually two types of 203K loans you can get – the streamline 20K and the full 203K. Here are the differences:
- The streamline 203K provides enough money to make renovations up to $35,000. You can make just about any changes except those that are structural. You can’t add rooms, knock down walls, or make other structural changes. You can do things like replace the windows, replace the flooring, or paint the exterior of your home, though. The lender will disburse the funds in 2 installments – at the start of the project (usually 50%) and when it is complete and you approve of the work.
- The full 203K is the loan that will allow up to 110% of your home’s after renovation value in a loan. You can make structural changes with this loan, as long as the contractor can finish the work in six months or less. With this loan, you need to hire (and pay for) a loan consultant. This professional oversees the project, helps you with your loan, and manages the fund disbursement. The lender allows disbursement according to the contract they drew up with the contractor. They usually offer a disbursement up front, at some mid-point check, and then again when the contractor completes the work.
Keep in mind with any FHA 203K loan, you will pay mortgage insurance for the life of the loan. You will also pay an upfront mortgage insurance fee, which is equal to 1.75% of your loan amount.
You have several options when it comes to obtaining the financing necessary to renovate your home. Make sure you explore all of your options. Compare the monthly payment, the interest rate, the APR, and the total cost of the loan over its lifetime.