We’re at that time of year again. Spring is right around the corner, and homeowners are trying to scratch the itch. They’re starting to wonder if it’s time to consider moving to a new home or improving the one they currently live in. While most of us love (or really enjoy) where we live, it doesn’t mean we don’t have a running wish list of things we’d like to improve. For some, that wish list may be significant enough to motivate us to look for a new house, but others may be able to accomplish what they wish purely through home improvements. But how do you pay for them?
Let’s start with defining equity and why it’s important. Equity is the difference between the asset value of the home and the associated liability that’s owed (mortgage or lien). For two of the options discussed today, you need a certain amount of equity, and for the third option, you don’t need equity.
Cash-out refinance – Option #1 (also my personal favorite)
Depending on the amount of your home improvement and the equity you have, doing a standard cash-out refinance is a great option. Here’s why:
- The rate will be lower
- The rate will be fixed
- Maintains the ability for only one lien against the property
This is a loan where you’d add the amount of cash needed for the improvement to the amount you already owe on the home to create a new total loan amount. Other than that, it’s a regular mortgage, meaning you make the same payment each month until the loan is paid off. It’s an installment loan with a defined amortization period. This option requires more equity than option two below so it could be a little limiting for some, however.
Home equity line of credit – Option #2 (more flexible)
This option is best if or when a borrower has an extremely low rate on their current mortgage- something not as likely today, yet still possible. This option is also best if a borrower doesn’t have enough equity to allow them to do a cash-out refinance. Home equity loans require much less equity and allow for more flexibility, much like a credit card. This means you pay for what you use up to the max limit you qualified for, but the downside is the rates will be higher and typically won’t be fixed.
Got no equity?
Home renovation loan
That brings us to renovation loans. Renovation loans require more planning but are a great option for when equity is limited and/or the improvement is substantial. How can a borrower get this type of loan without equity? They can use it by utilizing the future value of the home based on the appraised value after renovations are completed. An appraiser evaluates the scope of the improvements that will be made in consideration of what the property would be valued at, then a borrower finances up to 95 percent of that amount for this type of loan. The other benefit is that the rate is fixed (just like the cash-out refinance) and lower than the home equity lines of credit. The downside is that these loans require more time since the appraiser needs the know the scope of work, which contractor will be used, and which improvements are planned.