We’re in the middle of a series of columns on home improvement and remodeling, and after you’ve decided to spruce up your place, the next obvious question is, “How are we going to pay for the work?”
Here are some potential options, along with the possible benefits and drawbacks of each choice.
Cash is king
Of course, the best way to pay for anything (including work around the house) is to write a check for it. But that adage is only true if, after you write the check, you still have plenty of money left over for all of your living expenses and emergencies.
So unless you have at least twelve months’ worth of living expenses left over after your project is done, it may be better to borrow to pay the bills.
Lower interest rates, rising home prices, more generous appraisals, and friendlier lenders are the intertwined factors that make now the best time in a long time to borrow against some or all of the equity you may have established in your home.
Usually lenders don’t like you to borrow more than 80% of your home’s appraised value, but if your credit is decent and your income predictable, it’s fairly easy to borrow up to that 80% ratio.
“How” you do so depends on your needs, and your situation. If you aren’t sure when you’ll need the money or how much you might need, it might be best to get a “home equity line of credit”, or “HELOC”.
Once you’re approved for a HELOC, you can borrow as much as you want when you want, up to the limit established by the lender. You only pay interest on what you borrow, and the interest rate can rise or fall while you have the HELOC.
After a period of time (perhaps ten years or so) the lender may request that you pay off any unpaid balance, or convert the HELOC to a fixed-rate loan with perhaps a ten-or twenty-year term.
If you know how much money you’ll need and you’ll need it right away, you may prefer to instead get a home equity loan. You request an amount from your lender, and if approved, you’ll get a check for that amount right away.
The interest rate is usually fixed, and repayment of principal and interest is usually required to start as soon as you get the loan. The term can last a few years or a few decades, but you can usually pay off the home equity loan at any time with little or no penalty.
Go big, go long
If you have some larger projects in mind, would like the lowest possible interest rate, and the lowest possible monthly payment, you may want to consider refinancing your current mortgage to a new, 30-year fixed-rate loan.
The amount of the new mortgage should be at least as much as you need for your home improvements. But if possible, you may choose to borrow more than that amount.
The extra funds can be used to pay off higher interest rate debt (such as credit cards, consumer loans, or education loans), or set aside to pay for unexpected emergency expenses.
Just try to keep the new mortgage amount to no more than the aforementioned 80% of the home’s appraised value, so that you can avoid having to pay for private mortgage insurance.
Best of all, if you have more money than you know what to do with in the future, you can always pay the mortgage off with little or no penalty.
But if interest rates rise, home values fall, lenders become more strict, or your personal financial situation deteriorates, you’ll be very glad you took out a mortgage today.
When your home remodeling needs exceed your available cash and home equity, you may have to consider other alternatives. So we’ll go over some non-traditional ways to finance the work.
In the meantime, you may want to turn off the home improvement TV shows and call your bank or credit union.