Choosing the right mortgage
Homeowners who choose the wrong home improvement loan can throw away a bunch of money. But there is no right or wrong choice.
Which solution is best for you will depend on how much you want to borrow, your credit quality, and “equity” (the amount by which the market value of your home exceeds your mortgage balance).
To equip yourself with the information you need to make an informed choice, keep reading.
Check your new rate (Sep 25, 2021)
1. Credit card
Average credit card rates at the time of writing are 16.7 percent. So you don’t want to borrow a lot, or for a long time, with plastic. Still, there are three ways smart people use their cards to improve their homes:
- When they want to borrow only hundreds and can easily pay back quickly
- When they want to earn rewards, and will pay the balance in full
- When they get a card with zero percent APR on purchases up to 21 months, provided they can pay off the debt during that time
Cards are often the least complicated: you use an existing line of credit. And, even if you apply for a new card, the process is quick and free. Just avoid borrowing more than you can pay off quickly.
2. Personal loan
These typically have lower interest rates than credit cards, and with fixed interest rates and payments, they make budgeting easier. But these are still higher than the other types of loans explored below. So, personal loans may be preferable if you are borrowing small amounts, perhaps $ 1,000 to $ 5,000.
If you have a rewards credit card, you might want to add upgrades to it and then pay it off with a personal loan at a better rate.
Again, you will likely get a decision on your claim quickly and with little hassle. During this time, the installation costs are generally low and often free.
If you want to borrow larger sums, the options below almost always have lower rates. However, expect significant installation costs and more administration with them. And they’re also “secure,” which means you could face foreclosure if you can’t keep your payments.
3. Home equity loan
You borrow a lump sum and pay it back in equal installments over an agreed period. And you will probably get a fixed interest rate. It is therefore a simple, direct and very predictable loan.
Since second mortgages are riskier for mortgage lenders than first mortgages, you will pay a higher interest rate. But because the loan is secured by your home, it is less than any other financing.
This is a second mortgage, so be prepared to provide plenty of documentation before closing. And closing costs can be significant, although they’re usually not as high as for a first mortgage. They can often be accumulated in the loan.
4. Home Equity Line of Credit (HELOC)
A HELOC shares features with both a home equity loan and a credit card. It’s always a second mortgage. However, the closing costs are lower (or even zero, in some cases) and they tend to be processed faster.
Like plastic, you get a credit limit, and you can borrow and repay up to that amount as often as you like. Better yet, you only pay interest on your outstanding balance.
This flexibility can be very attractive for multi-phase home improvement projects, where the money needs to be invested over longer periods of time.
HELOCs can be more difficult to budget because they almost always come with variable interest rates. In addition, each HELOC has two phases: a “debit” phase, in which you can use and reuse your credit as much as you want, and a “repayment” phase, when you can no longer borrow and must repay the balance. over the remaining years of the loan.
Some HELOCs allow you to set your interest rate once you enter the repayment period. They are called “convertible” HELOCs. Just make sure you understand how your line of credit works.
5. Mortgage refinancing
A home equity loan or HELOC gives you a second mortgage. But you may prefer to refinance your existing first mortgage instead.
You will then only have one loan. And you’ll likely get a slightly better rate than what second mortgages typically get. But you will usually have to go through the entire mortgage application process.
And closing costs can be higher than with other types of loans. However, you may be able to accumulate these costs as part of the loan.
5a. Cash-out refinancing
If you have equity in your home, you may be able to access some of it by using cash refinance. This allows you to get the cash by which you increase your mortgage balance, less fees. And you can spend that on home improvements or whatever else you want.
Obviously, this is especially interesting if your current mortgage has a higher interest rate than the new one. In this case, your monthly payments could hardly budge.
But it’s often a bad idea to refinance at a rate higher than your current rate. You might be better off using a home equity loan or HELOC. This way, only a portion of your loan is at a higher rate. Use a mortgage calculator to model your options.
5b. 203k FHA loan
These 203k loans from the Federal Housing Administration are loaded with pros and cons. Perhaps the biggest advantage is that you can borrow against your future home equity because the loan-to-value ratio is based on improving the value of the property.
Another advantage is that you have a good chance of getting approved, even if your credit score is not that impressive.
But perhaps the biggest downside is that you’ll have to pay mortgage insurance premiums (MIPs) until you sell your home or refinance again.
5c. Streamline 203k loan
If your budget (including a 15% contingency) is $ 35,000 or less, you may be eligible for a streamlined version of the FHA 203k loan. However, you need to be able to stay in your home throughout your project.
What is the advantage? You get a smoother process, including fewer paperwork requests and straightforward payments to your contractor.
Fannie Mae’s HomeStyle® Renovation loan looks a bit like the $ 203,000 FHA loan. But it’s often cheaper and easier to close. And it can be more flexible. You can even use one for your vacation home or investment property.
The wrong side? You will likely need a better credit score than that required by the FHA.
6. Other types of borrowing
For the most part, the above are probably the smartest choices for home improvement loans. But, in exceptional circumstances, it may be worth considering others.
You could, for example, borrow from your 401 (k) retirement program. Or, if you’re 62 or older, you might be thinking about a reverse mortgage, aka a home equity conversion mortgage (HECM).
However, you must consider the strategic financial implications of these methods. Only use one if you have followed the financial advice of a trusted and experienced professional.
Check your new rate (Sep 25, 2021)