Home Improvement Financing For Contractors – Home renovations can be expensive. But the good news is that you don’t have to pay out of pocket. A home improvement loan allows you to finance the cost of upgrades and repairs to your home.
Specialized rehab loans like the FHA 203(k) loan exist specifically to finance home improvement projects. And there are other mortgages — home equity loans and HELOCs — that can provide cash for a home improvement or any other purpose.
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So what is the best home improvement loan? It depends on your needs. Here’s what you should know.
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A home loan (HEL) gives you the opportunity to borrow against the equity built up in your home. Your equity is calculated by assessing the value of your home and deducting the outstanding balance on your existing mortgage.
Unlike a cash-out refinance, a home equity loan does not pay off your existing mortgage. If you already have a mortgage, you will continue to make its monthly payments while also repaying your new home loan.
A home equity loan “spreads like a single payment up front. It’s like a second mortgage,” says Bruce Ailion, real estate agent and attorney.
With a equity loan, your house is used as collateral. This means that lenders can offer lower rates because the loan is secured against the property. The low, fixed interest rate makes a purchase loan a good option if you need to borrow a large amount.
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Remember that you will likely pay closing costs between 2% and 5% of the loan balance for your home loan. So be sure that the amount you borrow makes the extra cost worth it.
As a bonus, “a home equity loan or HELOC can also be tax deductible,” says Doug Leever with Tropical Financial Credit Union, Member FDIC. “Check with your CPA or tax advisor to be sure.”
A home equity line of credit (HELOC) is another great way to borrow from your home equity without refinancing. A HELOC is similar to a home equity loan, but works more like a credit card. You can borrow from it up to a pre-approved limit, pay it back and borrow from it again.
Another difference between home equity loans and HELOCs is that HELOC interest rates are adjustable; they can rise and fall over the loan period. But interest is only payable on your outstanding HELOC balance — the amount you actually borrowed — and not the entire line of credit.
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You can only borrow a portion of your maximum loan amount at any time, which means that your payments and interest expenses will be lower.
A HELOC may be a better option than a home equity loan if you have a few lower-cost or longer-term remodeling projects that need to be financed on an ongoing basis.
At the end of the term, “the loan must be paid in full. Or the HELOC can convert to an amortizing loan,” says Ailion. “Note that the lender may be allowed to change the terms during the term of the loan. This can reduce the amount you can borrow if your credit goes down, for example.”
Still, “HELOCs offer flexibility. You don’t have to take money out until you need it. And the line of credit is available for up to 10 years,” says Leever.
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Another popular way to get money for a home remodeling project is a cash-out refinance. With this option, you refinance to a new mortgage with a larger balance than you currently owe. Then you pay off your existing mortgage and keep the remaining cash.
The money you receive from a cash-out refinance comes from your equity. It can be used to finance home improvement projects such as finishing a basement or a kitchen remodel. However, there are no rules stating what the funds are to be used for.
A cash-out refinance is usually the best home improvement loan when you can lower your mortgage and take cash out. This only works when the current market rates are below your existing rate.
You may also be able to adjust the term to pay off your home faster. For example, let’s say you had 20 years left on your 30-year loan. Your cash-out refi can be a 15-year loan, which means you are scheduled to pay off your home five years earlier.
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So how do you know if you need a cash-out refinance? Start by comparing costs over the life of the loan, including closing costs. This means looking at the total cost of the new loan versus the cost of keeping your current mortgage for its lifetime.
Keep in mind that cash-out refinances have higher closing costs — and they apply to the entire loan amount, not just the repayment. So you’ll likely need to find an interest rate significantly lower than your current one to make this strategy worthwhile.
With the FHA 203(k) program, you don’t have to apply for two separate loans or pay closing costs twice. Instead, you finance your home purchase and home improvements at the same time when you buy the house.
FHA 203(k) rehab loans are great when you’re buying a fixer-upper and know you’ll need financing for home improvement projects right away. These loans are backed by the government, which means you get special benefits – such as a low down payment and the ability to apply with a less-than-perfect credit profile.
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On the other hand, this type of loan can take longer to close. “FHA 203(k) loans can be drawn out and difficult to get approved,” says Jon Meyer, The Mortgage Reports loan expert and licensed MLO. If you go this route, it’s important to choose a lender and loan officer familiar with the 203(k) process.
If you don’t have enough equity to borrow from, a personal loan is another way to finance home improvements.
Because a personal loan is unsecured, you will not use your home as collateral. This means these loans can be obtained much faster than HELOCs or private equity lines of credit. In some cases, you may be able to get loan financing the next business day or even same day financing.
Personal loans can have adjustable or fixed interest rates, but they are typically higher than those for a home equity loan or HELOC. That said, if you have excellent or even just good credit, you can probably get an affordable price.
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The repayment period for a personal loan is less flexible, often two to five years. And you’ll likely pay closing costs, too.
These terms may not sound so favorable. But personal loans are more accessible than HELOCs or home equity loans for some borrowers. If you don’t have much equity in your home to borrow against, a private loan can be an option to pay for home renovations.
These loans also make sense for financing emergency home repairs—if your water heater or HVAC system needs to be replaced right away. Still, Meyer warns that personal loans are the “least advisable” option for homeowners.
You can also finance some or all of your remodeling costs with plastic. This is the fastest and simplest financing option for a home improvement project. After all, you don’t even need to fill out a loan application.
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But because home improvements often cost tens of thousands of dollars, you’ll need to get approved for a higher line of credit. Or you need two or more credit cards. Additionally, you will likely pay higher interest rates than those charged by home improvement loans.
If you must use a credit card to finance your renovations, try applying for a card with an introductory 0% annual percentage rate (APR). Some cards offer up to 18 months to repay the balance at that introductory rate. This approach is only worthwhile if you can pay off your debt within this repayment period.
Like personal loans, credit cards may be acceptable in an emergency. But you shouldn’t use them for long-term financing. Even if you have to use credit cards as a temporary solution, you can later get a secured loan to pay off the cards.
The best home improvement loan will match your specific lifestyle needs and unique situation. So let’s narrow down your options with a few questions.
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If so, you can access the lowest interest rates by borrowing against the equity in your home with a cash-out refinance, home equity loan or home equity line of credit.
If so, check out the FHA 203(k) program. This is the only loan on our list that bundles home improvement costs with your home loan. Just review the guidelines with your loan officer to make sure you understand the disbursement of the fund rules.
Taking out just one mortgage to cover both needs will save you money on closing costs and is ultimately a more straightforward process.
“The only time I would recommend the FHA203(k) program is when I’m buying a fixer-upper,” says Meyer. “But I would still advise homeowners to look into other loan options as well.”
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When you need an emergency home repair and don’t have time for a loan application, you may need to consider a personal loan or even a credit card.
Just remember that these options have significantly higher rates than secured loans. So you will
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