Balancing your planning between your dream outcome and how much you are willing to spend often means planning renovation projects. Almost every home remodel includes a list of several costly projects. Paying cash to get ripped off on construction costs undermines your emergency savings.
Home improvement loans are a great way to finance the construction/upgrades to your home. An improvement loan can be a good option if you want to keep your home improvement unaided construction costs from escalating as you venture to remodel your home.
Managing construction costs to address necessary repairs will depend on the option you chose to finance the remodel. Avoid bank loans if you can and focus on understanding the available products. Doing this will likely mean your necessary repairs will be at the lowest construction costs. This guide tells you more about how to balance construction costs and home improvements.
Exploring Financing Options
There are many different types of financing options that are available to you as a debtor. Prior to moving forward on a financing application, you will want to consider how different options align with your project’s size and timeline, as financing options will vary. For instance, financing options for ‘home improvement loans’ typically can be categorized as either secured or unsecured loans.
Unsecured Loans
An unsecured personal loan can be a very attractive option for a debtor as there is no need to put your home at risk and back the loan with your home as collateral. For many debtors, unsecured personal loans are the quickest pathway to moving the project forward.
Best for: Projects that are of medium size, funding is required quickly (within a matter of days), and borrowers are those with good to optimal credit.
Pros: There are fixed interest rates that ensure there will be no surprises along the way, equally fixed monthly payments with no need to worry about home equity appraisals, and will leave equity untouched.
Cons: The repayment periods are typically shorter (generally 2 to 7 years) and thus will require refinancing at higher interest rates than secured loans.
Secured Loans
A secured loan is also considered a second mortgage. This will involve placing a secured collateral on the loan. Although this is typically a higher risk option, in the home improvement industry this is commonplace. It is also good to keep in mind that these loans can also be combined with a mortgage. What is advantageous with this option that is generally harder to get outside of the housing market is that there are typically lower interest rates than personal loans. Subsequently, this option may allow you to pay less in interest because in addition to that interest being lower, you may also have the option of tax deduction on the interest with the loan. However, home equity loans cannot cover small monthly payments.
If you default on a loan, you are liable to foreclosure. Closing costs are steep and approval processes are slower than personal loans.
Home Equity Lines of Credit (HELOCs).
HELOCs are similar to credit cards. Based on your home’s equity, you are granted a credit limit, and you can borrow against it during a “draw period,” which is usually 10 years.
Best for: Unfinished or ongoing projects
Pros: Interest is charged only on the borrowed balance. You are offered the flexibility to borrow and pay and borrow again.
Cons: Payments can change depending on how the market is performing since equity loans and HELOCs are collateralized to your home.
Government-Backed Loans (FHA Title I)
If your credit score is low or your equity is limited, the Federal Housing Authority (FHA) Title I loans could apply for you. These loans can only help you finance home improvements that are necessary to make the property more livable and useful.
Details: You can borrow up to $25,000 on a single-family home.
Terms: Loans can be for a maximum of 20 years.
Security: Unsecured loans are for amounts under $7,500. Loans over that amount are secured by a mortgage or deed of trust on the property.
Key Factors to Keep In Mind
When choosing loans, you should analyze more than just the monthly payment. You should analyze the total borrowing costs.
Loan fees and interest rates
The Annual Percentage Rate (APR) provides the most accurate costs of a future loan, and takes into consideration the interest and fees a lender provides. Personal loans are usually fixed rate loans, which can be easy to plan around. But, HELOCs can be more tricky because they are often a variable rate, which means they can start low, but increase even higher over time.
Loan upfron costs
Always analyze the loan costs.
Application Fees: Personal loan lenders often charge an additional 1 to 8% of the loan amount just to complete the application.
Loan Closing Costs: HELOCs and home equity loans often come with closing costs like appraisal fees, application fees, and attorney fees, just like a primary mortgage.
Prepayment Penalties: When you pay off your loan early, some lenders charge a fee. When analyzing the loan, the fine print should be checked to confirm prepayment penalties are not included so that you have the ability to pay off the loan early.
Collateral and Risk
Using your home as collateral for loans is a big risk you should think carefully about. Job loss or a financial emergency can lead to a foreclosure if you default on a secured loan. While unsecured loans cost a bit more in interest, they protect your collateral.
Where to Apply for a Home Improvement Loan
After deciding what type of loan you want, your next step is to determine your lender. Different financial institutions can be advantageous in different ways.
Traditional Banks
If a major bank is your mortgage lender or primary checking account holder, it is worthwhile to check their rate options. Existing mortgage customers may be eligible for relationship pricing (for example, a 0.25% interest rate reduction) and may also benefit from faster processing on application overrides. Banks are commonplace for home equity loans and HELOCs.
Credit Unions
Credit unions are owned by their members; as such not-for-profit institutions can offer more competitive pricing, with lower interest rates and less fees than to the larger banks. They may consider extending credit, where bigger institutions would decline, in looking more holistically at their borrowers instead of strictly a credit score. Still, with credit unions, membership criteria must be satisfied before applying for a loan.
Online Lenders
When it comes to speed and convenience, online lenders have the edge. They focus on personal loans and allow customers to pre-qualify to check estimated rates with no impact on the applicant’s credit score. Loan approvals are extremely fast; some online lenders can transfer funds to your bank account within 24 hours of loan approval.
FHA-Approved Lenders
You cannot obtain a Title I loan directly through the government, you have to go through a private lender that is HUD approved. You can find these particular lenders on the HUD website, or you can ask your local banks if they are participants in the program.
The Application Process
There are some loan securing steps that will definitely be applicable, and being proactive will help you a great deal to make this quicker.
Check Your Credit: Look over your credit reports to check for any mistakes before you submit the application. Your credit score will impact the interest rates offered and the amount you are offered to borrow.
Evaluate Your Equity: If you want to borrow against your property, you should determine how much equity you have and you can calculate this by subtracting your current mortgage balance from your home’s estimated value. Most lenders will limit how much you can borrow to 80-85% of your home’s value (this is referred to as the Combined Loan-to-Value ratio).
Prepare Your Documents: You will need to provide income documentation (pay stubs and tax returns), proof of identity, and your mortgage statements.
We recommend getting multiple rate quotes from lenders. When looking at rates, be sure to consider the total payment including any fees, which are reflected in the APR. If a loan has a cost that is higher than the expected payment, the loan is considered to have a “balloon payment.” Always look out for these types of costs because they can be cost prohibitive at the end of the loan term.
Be wary of contractor financing, especially if a contractor tries to arrange the financing for you. Some contractors may be decent and have a strong partnership with a genuine lender. However, this is a common area for deception. Prospective contractors may pressure you to agree to a deal right away, present financing terms that seem unreasonably low, or ask you to transfer proceeds from the loan to the contractor directly. Always check the lender out for yourself.
To improve your chances of securing a loan, you can consider these 4 strategies. Before making the loan application, pay off any credit card debt to help your debt to income (DTI) ratio. A lower DTI ratio and higher income provide evidence to lenders that you can afford to take on a new loan payment. If your credit score is low and you are concerned about getting a loan, consider getting a co-signer. A co-signer likely has a strong credit score and this will likely increase the chance of securing a loan, and may even lead to a lower interest rate.
Start Small: If you qualify for less than the full amount, consider completing your renovation in phases and apply for a smaller loan amount first.
Making Your Renovation a Reality
Borrowing money for home renovations can be a daunting process, but can be worth it in the long run by increasing the value of your home and improving your quality of life. Financing home renovations through personal loans, equity loans, and government loans differ in a lot of important ways. Understanding these distinctions will help you choose the pathway to financing your renovations in line with your financial objectives.
As you weigh your financing options, be sure to take your time. Make sure you compare offers from traditional banks, credit unions, and online lending platforms. You want to find the financing option that offers the flexibility to help you achieve your goals without excessive financial strain.