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Seeking to buy a house in need of some TLC? Eager to upgrade your kitchen? In dire need of an HVAC repair? Got a garage that's falling apart? Each of these goals can cost serious dollars. That's a big reason why many homeowners look to borrow money to fund the project.
Thankfully, there are many options to choose from. For example, financing can come in the following forms:
- A home renovation loan.
- A cash-out refinance of a mortgage.
- A home equity loan.
- A home equity line of credit (HELOC).
- A personal loan (unsecured loan).
- Charges on one or more credit cards.
The good news? With a favorable credit score and credit history, you'll likely qualify for one or more of these options.
Each has its pros and cons, and every choice comes with a serious responsibility to pay back your debt. But borrowing responsibly can be a better option than depleting your savings. That's especially true now, when interest rates remain near historical lows and experts recommend keeping an extra-large emergency fund set aside due to COVID-19 and other variables.
Buying a fixer-upper? Look into a home renovation loan
You've got your eye on a diamond in the rough -- a residence that needs repairs. You could take out a typical mortgage loan and finance the fixes later. But it may make more sense to get bundled into your mortgage loan a home renovation loan that covers the expenses of remodeling that home in disrepair. This way, you only have to close once and make monthly payments to one lender.
Here, there are many products to pick from. First, you can opt for two kinds of FHA 203k loans:
- A limited (streamline) loan that offers up to $35,000 for renovations that don't include major structural fixes.
- A standard loan in which renovations tally a minimum of $5,000, which can include major structural repairs.
With either, you're required to enlist a Department of Housing and Urban Development (HUD) consultant to supervise the renovation process.
Second, there's the Fannie Mae HomeStyle Renovation Mortgage, available for 15 or 30 years as a fixed- or adjustable-rate loan. Your final loan amount depends on your home's projected value once the renovation has finished.
- EZ “C”onventional loans: This kind of loan can bundle your renovations into the original loan and structure it similarly to a conventional loan. It covers borrower-requested or appraiser-required renovations provided they add value to the residence over time.
- Jumbo renovation loans: These loans offer funds for basic repairs and upgrades to your home. They can also be used for appraiser-requested or borrower-requested repairs that add value to the home, but they can't be used to fix structural issues.
- The Rural Housing Repair Loans and Grants program: This program offers grants and loans to very-low-income homeowners to improve, fix, update, or remove health and safety hazards in their rural dwellings. Loans are arranged for up to 20 years at 1% interest. Grants may be arranged for recipients who are 62 years of age or older and can be used only to pay for repairs and improvements to remove health and safety hazards.
Consider a cash-out refinance
You've been making mortgage payments for a while now. That means you've accumulated hefty equity. This equity can be withdrawn from your home in the form of cash that can be pocketed at closing if you refinance your mortgage loan.
This can be a win-win for you if mortgage interest rates have fallen since you bought your home or last refinanced. Not only will you lower your rate; you'll also get a lump sum payment at closing to be used on home upgrades.
With a cash-out refi, you can choose a fixed or adjustable rate. You can also choose a term that's best for you, usually 10 to 30 years. If you're refinancing from, say, an original mortgage that had 25 years left to a 20-year mortgage loan, you're instantly shaving off five years of payments. That can save you thousands otherwise spent on interest.
On the other hand, if you're taking cash out, you may have to reset to a longer term to afford the monthly payments. The downside of a cash-out refinance is that the closing process is lengthier and costlier than with other loan options. On the brighter side, among all the financing choices listed in this article, a cash-out refi will likely offer the lowest interest rate.
Check out a home equity loan
If you've built up enough equity in your home, you can pursue a home equity loan. With this option, the loan works like a second mortgage and your property is used as collateral. In other words, if you cannot make your monthly payments, you could lose your home. Your equity is calculated by subtracting the outstanding balance due on your mortgage loan from your home's value.
Home equity loans can either be fixed-rate loans or adjustable-rate loans, and your term can range from as little as a few years to 15 or more. Note that you'll pay closing costs on this loan.
With a home equity loan, the entire amount you borrow is dispersed upfront once you've closed on the loan. You begin making monthly payments shortly after closing. Fortunately, you may be able to deduct from your taxes the interest charged.
Depending on the lender, the amount you can borrow will have a ceiling. This amount is commonly based on a loan-to-value ratio of up to 90 percent of the value of your home.
Look into a home equity line of credit (HELOC)
Like a home equity loan, a HELOC requires you to use your home as collateral and is akin to a second mortgage. But what's different is that you don't receive a lump sum payment. Instead, you are given a revolving line of credit and allowed to withdraw funds over a set draw period, typically the first decade or so. You also have a preapproved spending limit, which depends on your earnings and credit score.
A HELOC offers flexibility. You only tap into your equity and borrow funds when you need it. Plus, you can withdraw any amount you choose multiple times, up to your total spending limit. As with a home equity loan, provided you have sufficient equity, good credit, and a stable income, it's relatively easy to qualify for a HELOC. In fact, it may be easier to get approved for a HELOC than a home equity loan, as lending rules are often looser.
Here's another plus: With a HELOC, you only have to start repaying what you borrow when there's a balance owed. Let's say you're motivated to remodel your master bathroom. Problem is, you may have to postpone this project for a year or so because you're busy right now caring for an ailing relative. Well, you can apply and get approved for a HELOC now and wait until you're ready to withdraw -- even if it takes a few years.
Additionally, you don't have to worry about interest accruing until you actually tap into that line of credit. And to sweeten the deal, the interest owed may also be tax-deductible.
Pursue a personal loan
Don't want to use your home as collateral? Consider a personal loan. This is an unsecured loan that simply requires your signature, if you qualify. A personal loan is an especially good option if you haven't built up enough equity in your home to tap into. And your lender won't care what you use the borrowed funds for, even if you don't ultimately use it to pay for remodels or repairs.
While it's pretty easy to get approved for a personal loan, be forewarned: The interest rate on a personal loan can be higher than for a home equity loan, HELOC, or cash-out refinance. You may be quoted a lower rate if you have a lower debt-to-income ratio and a higher credit score.
You can select a short-term personal loan, with a repayment period of 12 months or less, or a personal loan with a longer term, up to 60 months or longer, depending on what the lender offers.
Ponder a not-so-fantastic plastic option
As a last resort, you could charge renovation expenses on credit cards. The advantage is that you can use one or more cards that you already have in your wallet, up to your spending limit. The disadvantage is that most credit cards tack on higher interest rates than any other financing option covered here.
But you don't have to settle for the credit cards you currently carry. Instead, try applying for a credit card with a special low introductory rate; some cards even promise 0% APR for the first several months, which can be a good deal if you plan to pay off your charged expenses fully within that introductory no-interest period.
Other considerations before committing to financing
Whatever financing option you choose, prepare to perform the needed due diligence. That starts with comparing interest rates. Here, don't dwell solely on the rate or monthly payment. Learn what the APR is; this is the annual percentage rate, which reflects the interest rate along with applicable fees.
Next, do a careful apples-to-apples comparison of features, terms, and rules. Case in point: Lender A may boast a low APR but tack on a lot of fees. Lender B may promise to close the quickest and waive most fees but charge a higher interest rate.
Also, plan out your home improvement project carefully. Get quotes from several different contractors or experts, and try to calculate what your expenses will be. This can make it easier to decide how much money you need to borrow in the form of a loan, HELOC, or cash-out refi.
Lastly, remember to allow some wiggle room. Every project comes with unexpected costs and unforeseen challenges, so include a cushion in your budget.
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