Dreaming of a home that is remodeled to fit your needs and desires is a great past time. Last week’s article, The 5W’s of Home Remodeling discussed things to consider if you would like to get started.
If you are ready to get serious about the remodeling process the next step is figuring out the funding aspect of the project. If it is something you have dreamed of doing for a long time, maybe you have already set aside some funds. Let’s discuss the more common methods of financing home improvement that we have seen our customers use over the years.
Home Equity Loan:
If you don’t have the cash on hand, consider a Home Equity Loan, also known as a second mortgage. Most lenders will lend up to 90% of the current value. That means you’ll need to have 10% equity in your home. An appraisal is performed to determine the amount a homeowner is eligible to borrow. The difference between the appraisal of the home and the ballance on your mortgage determines the amount that can be borrowed.
The advantages to this type of loan are that the interest rate is tax-deductible, and the interest rate is lower than other personal unsecured loans. However, the interest rate on a Home Equity Loan is generally higher than your first mortgage due to more risk to the lender. In the event of default, the first mortgage gets priority. Still, they are popular loans as the borrower can use the money as he chooses.
A construction loan starts with a 2-part appraisal:
- The first step is an ‘as is’ traditional appraisal which determines the current value of your home.
- Next, the ‘subject to’ appraisal accesses the value of your home as if the project has already been completed.
The ‘subject to’ appraisal requires a detailed look at the cost of the project. Harold Perkins of Rosie on the House Certified Galaxy Lending Group says his company works closely with clients to examine the return on investment for the project and assure that it will add additional value to your home. To get a head start, homeowners can access the Cost vs Value Report, an annual report that evaluates the return on investment (ROI) for remodeling projects by Remodeling Magazine. For instance, a medium kitchen remodel averages a 62.9% ROI.
You can expect the lender to analyze the project to make sure the improvements are correctly supported by the appraisal future value. The contractor will be investigated to make sure their subcontractor paying habits are positive. Of course, you don’t want folks doing major projects on your home unless they are licensed, bonded, and insured. Some lenders will allow you to do the work yourself as long as those supervising the project have the required experience. The choice of contractors ultimately rests on the homeowner. Check out Rosie’s How To Choose A Contractor Consumer Guide.
If the interest rate of the loan is higher than the primary loan it would be best to set it up as a secondary loan. If the interest rate is the same or lower, it can be rolled up with your primary loan.
The average interest rate on a construction loan is now 4.5% to 4.75% as opposed to a conventional loan at 3.85% to 4.25 %; keep in mind that rates can change daily. This changes individually based on loan to value, amount of home equity and personal credit scores. There will likely be a built-in 10% contingency for overages for protection in the event of some unforeseen cost, or your contractor going out of business. This higher rate is needed to cover the risk the mortgage company is taking.
The size of the project usually determines whether or not the financing is done with a construction loan or second mortgage. Smaller projects tend to be second mortgages. Larger projects tend to be construction loans.
The following are some considerations if you are buying a home that you know will need some amount of remodeling.
Smaller Down Payment
Instead of borrowing money, negotiate a smaller down payment on the home and use the money saved to complete the work.
Do Your Homework
When considering a fixer-upper, do your homework. Depending on the interest rate, you might get more for your money moving into a move-in ready home. The advantage to remodeling, of course, is that you get to personalize the finishes in your home.
The HomeZada App has a financial tracking system that among many other features, makes tracking the equity in your home easier. If you used to balance your checkbook with a pen and a piece of paper and then converted to Quickbooks, then you understand how much HomeZada can simplify this task. HomeZada regularly updates to keep you informed about your loan to ratio value, estimated home value, and your home value forecast. It is a great tool for managing your home and understanding how it contributes to your overall financial health.