Dollars & Sense- Tips on Borrowing Funds for Home Projects
If you’re like many Americans, buying your “dream house” is out of the question right now. But just because you can’t purchase a new home doesn’t mean you have to go without the extra bedroom, bathroom or kitchen you want. You just have to find the right people to help you get what you want.
“This is an excellent time to take on a home project,” whether it is an addition, renovation or just a simple improvement, says Mike Thomas, CEO of Select Bank.
First of all, it’s just plain smart to invest in your home. Right now, renovation costs are down and construction companies and contractors are bidding with competitively lower prices. Given that trifecta, how can you not hit the home improvement store and start dreaming big?
If you’re still not sold, think “saving money.” Some of the new products that you can put in your home—from water heaters to kitchen appliances—are more energy efficient than what was installed when your home was first built. When they use less energy, your energy bill goes down. Then there is the money that comes when you are ready to sell. With few exceptions, home improvement projects make your home more valuable. Renovate your kitchen or bathroom, for example, and you will likely get a 75 to 100-percent return on your investment.
If you have the cash to take on a renovation, then great—get going. If not, big box stores are often eager to provide you with credit, and banks have a number of methods to help get you the funds you need.
Always start at the beginning. What specifically do you want to do? Size matters. A small project, like putting in a new sink and toilet, will require one kind of funding and can be done with muscle and know-how. A $250,000 addition calls for a different funding stream and a quote from a licensed and insured contractor.
Before you consider borrowing money, says Bob Chapman of Bank of the James, “think through how it affects your home budget. You don’t want to be house poor. You don’t want to have a great addition and then not be able to buy bread at the grocery store.”
For a small project, one less than $5,000, Chapman recommends the personal loan. With this type of loan, you avoid the closing costs that come with other types of loans.
Another option, if you need less than $5,000, can be a store credit card. That comes with a big “if” though. It only works if you can pay it off during a credit card’s introductory rate period and you read that fine print. Whether it is a good idea for you or not depends on what kind of interest rate the card carries, and if you can pay off the full amount during the free introductory rate period.
If a credit card and a bit of manpower won’t cut it, it’s time to prepare for the bank visit. That means knowing your credit history, your home’s value and your equity, your household income and liquid assets, your debts, how much the entire project will cost, and just a bit of bank lingo.
To find out how much equity you have in your home, you need to find out how much the house is worth. That information can be found on your local city/county assessor website. Next multiply your home’s value by .85. Then subtract any debt (typically a first or second mortgage) on the property. That final number is your equity and is a good indication of what a bank is likely to be able to lend you, says Bob Chapman of Bank of the James.
Different banks have different options, but the most common choices are going to be Home Equity Loans, Home Equity Lines of Credit and Construction Loans. Home Equity Loans, or HELOs, are good for one-time projects, and Home Equity Lines of Credit, or HELOCs, are good for ongoing projects. Both use the equity in your home as collateral.
“You don’t want to use your Home Equity Loan for lifestyle, to go out to dinner three times a week or something like that, or if you are going to be moving in two to three years,” says Thomas. Customers need to know themselves and if they have the discipline to use the loan wisely.
There are times when the equity in your home may not lead to a large enough loan though. In that case, Chapman says to ask your bank if you can “have an appraisal based on the improvements.” That is one way to increase your loan amount, he says.
When you don’t have enough savings, liquid assets or equity in your home to use as collateral, a construction loan can be another avenue to pursue. They are most commonly offered by community banks and provide a specific amount of money to the contractor each time a certain project is completed.
Lenders recommend borrowers look at the rates of a number of banks to make sure they get the best rates. Lenders also stress the importance of going back to a bank that has served you well in the past. And always consider if being in debt is OK for you and your family.
“Ask yourself, ‘Am I taking on this debt to take on an appreciating or depreciating asset?’ If it is a depreciating asset, you really need to look hard at it,” says Thomas.
• HELO: Home Equity Loan. A block of money loaned to homeowners that comes with a fixed payment over a set amount of time. Recommended for larger loans.
• HELOC: Home Equity Line of Credit. A loan with a variable interest rate. Best for borrowers who can pay them off relatively quickly. Payment amounts are not pre-set. Allows borrowers to pay for improvements over time.
• Construction Loan: Available when contractors outline project schedule dates. Money is advanced to the contractor upon completion of each project on the schedule. The loan amount is based upon the market value of the home once the renovation is complete.
• Home Center Project Cards: Credit cards from home project stores that typically come with low introductory rates. You can pay the loan back over time. Beware of rising interest rates once the introductory period ends.
• Lendable Equity: Usually 80 to 90 percent of your home’s current market value minus your mortgage debt.
(Sources: Mike Thomas, CEO of Select Bank; Bob Chapman, Bank of the James)