Where Should You go to Finance Your Home Improvement Project?
Sure, you tackle home improvement projects yourself when you have the time and requisite skill level, but some projects may be outside your wheelhouse – and your budget. According to Home Advisor, the five most popular and most expensive home improvement projects range in cost from $6,000 to $10,000 to reface kitchen cabinets, build a deck, put on a new roof or remodel a bathroom, to more than $20,000 for everyone’s favorite upgrade – the kitchen remodel. You’re ready to bring in the professionals, but what do you do if the cost exceeds your monthly budget and you haven’t save up for it? Like every other major purchase, you finance it. The contractor itself may even offer financing, so you don’t have to bother going anywhere else to get the funds. Is this a good idea, though? Read on for some of the potential pitfalls of contractor-based financing, along with some other options you may wish to consider instead.
What are my options for a home improvement loan?
Banks and other lenders offer a host of different ways you could finance a home improvement project. Here are some of the most common options, along with their pros and cons for your project and pocketbook.
Home Equity Loan
As the name implies, you borrow against the equity built up in your home. A home equity loan is like a second mortgage, since the loan is secured by the home. Loan-to-value ratios range from 85% to 100%. Let’s assume a home equity loan at 85% LTV. Start with 85% of your home’s value, subtract what you owe on your first mortgage, and the remainder is the amount you can borrow against. You’ll be charged a fixed interest rate that is likely higher than the standard mortgage rates but lower than what a credit card would charge. On the plus side you can borrow more with a home equity loan and finance larger projects, and your interest payments may be tax-deductible. On the down side as 30 years. A long repayment period can keep monthly payments low, but it also means you’ll pay more in interest over time than you would with a shorter loan.
Personal Loan
A personal loan is unsecured, so you don’t have to put up your home, car or other property as collateral. With a personal loan, you can borrow as little as $1,000 or as much as $100,000, although many lenders won’t lend more than $50,000 for a personal loan. Your interest rate will be based on your credit score, but expect it to be higher than what a home equity loan would charge. You’ll have a much shorter repayment period, typically three to five years, which means you’ll have a higher monthly payment but also pay less interest over time. A personal loan is more suited to smaller home improvement projects; a home equity lender would likely require you to borrow at least $10,000.
HELOC
A home equity line of credit, or HELOC, is not a second mortgage, although you are suing the equity in your home as collateral. The lender would not foreclose if you failed to pay off the loan, but they could put a lien on your house. A HELOC gives you a revolving line of credit to use for home improvement or other spending. The term is split into a draw period and a repayment period.
Cash Out Refi
If the terms are right, you can replace your old mortgage with a new one. You’ll get your equity out in cash, which you can use to pay for improvements. You’ll be starting over with a new mortgage and new equity, but the payments may be less. You may have to pay closing costs and points for the new loan. Also consider that you are financing short-term costs with long-term debt, which may not make the best financial sense.
Home Reno Loan
If your project is truly adding value to your home, rolling the cost into your mortgage could make good financial sense.
FHA 230 (k) Reno Loan
If you’re buying a new house with an FHA loan, you may be able to borrow extra money at closing to pay for renovations. FHA 230 (k) loans can be limited or full.
Credit Cards
If you have enough available credit or multiple cards, you could always just charge the costs of your project, assuming your contractor takes credit cards. Of course, credit card interest rates are far above what you can get anywhere else, and out-of-control credit card debt is a leading cause of bankruptcy. On the other hand, there won’t be any fees or closing costs, and if you can get a new card with a low or zero interest introductory rate, this might be a smart way to finance a relatively small project that you could pay off in six months or so.
Save and Pay Cash
This route won’t cost you anything in interest or fees. It all depends on how soon yo want or need to get your project done, and if you are able to save up until you can afford to pay cash. If you can go this route, do it and save the most money. If you need to build up good credit, though, borrowing a little is not such a bad thing.
Should I let the contractor handle the financing?
Most financial experts say no. Contractors often get deals from sub-prime lenders that are loaded with hidden costs and fees. They may also fiddle with the price if they know you are financing through them. You may think you are getting a good deal, but you’ll pay more in the end. You’ll be better off nailing down the price for the job first and then getting financing from an outside source.
That said, just about every bank and major lender markets home improvement loans through contractors. Using contractor financing may give you confidence when going through a bank you know and trust and is another reason bot be wary of lenders you’ve never heard of.
Finally, consumer sites from Angie’s List to the FTC warn against paying cash up-front for home imrpvoement projects. If asked to pay up front for labor or materials, be sure and only make a partial payment that is truly needed. Use a check if possible for a written record, and get a signed contract or written receipt. Your credit card company will also offer protection if you charge these payments, but using a debit card won’t give you the same level of protection, if any. Home improvement companies have been sued from coast to coast, and the Consumer finance Protection Board may get into the act and regulate some of these companies or industries.
A federal law known as TILA (the Truth in Lending Act) gives you the right to rescind any contract signed in the home or that puts a claim on the home within three business days. Talk to a real estate or consumer law attorney if you think you’ve been defrauded into signing a contract or otherwise illegally taken advantage of. You may have a right to money damages for any harm done to you.
