You may be able to pay for a quick weekend DIY project with cash or credit cards, but larger projects such as a new roof or a major remodel can require you to explore other payment options. While that may seem intimidating, it can be straightforward if you do your homework and prepare. We asked Dave Gorman, a Divisional Sales Executive at Bank of America, to explain some of the best payment options available to homeowners.
Before hiring a contractor, it’s important to go over payment specifics — how much of a down payment is required and the due dates for future payments. (For more details on finding contractor, please visit Find a Pro.) During this time, ask your contractor about possible financing options. While it may not always be an option, some contractors offer financing plans through various lenders.
Home Equity Loan
A home equity loan is another name for a second mortgage, and carries with it a fixed low interest rate and tax benefits making it an attractive option for homeowners looking to pay for a major project. Because the money is available as a lump sum, home equity loans are ideal for large renovations and remodels.
How much can I borrow?
Typically, the amount you can borrow as a home equity loan is calculated by adding your current mortgage plus the amount you wish to borrow, divided by the total appraised value of the home (Not sure your home’s value? Check out this helpful online tool.). That gives you the Loan to Value Ratio (LTV). The rule of thumb is that banks look for an LTV of 80%.
As described at BankRate.com, “If you owe $100,000 on a house that’s now valued at $200,000, you could get an equity loan of up to $60,000. A loan that size would increase your total housing debt to $160,000, or 80 percent of the home’s value.”
While it may sound complicated, there are online calculators that can help you get an approximate idea of a loan’s value. However, as with any loan, you should always discuss the risks and benefits with your lender.
Home Equity Line of Credit
A home equity line of credit (HELCO) borrows against the value of your home, just like a home equity loan, but unlike a home equity loan, a HELCO acts as credit that is paid back with monthly interest. If you need more money in a specific month, you can use the credit and pay it back as you would a credit card.
Bonus: Interest can be a tax deduction
It’s often better than a credit card because a HELCO generally offers a lower interest rate and interest paid is fully tax deductible as long as the loan is used to improve the home. This includes repairs, renovations and upgrades however; if the credit is used to pay costs unrelated to the improvement of the home these expenses may not qualify. (Talk with your tax professional to learn if your loan qualities.)
“HELOCs offer a tremendous amount of flexibility,” according to Gorman. “Once the line of credit is opened, the borrower draws out funds as needed up to a pre-determined credit limit. For convenience, most financial institutions give you checks that can be used to pay directly from your home equity line of credit for services used and purchases made.” This can make it easier to pay contractors and purchase supplies.
“In addition,” Gorman added, “homeowners only pay interest on the amount actually used.” For greater flexibility, HELCO might be a better option than a home equity loan.
You’ll get better interest rates and more money from a home equity loan or HELCO, but sometimes you may want to start a project before you’ve built up equity in your home. Personal loans may be the answer. Personal loans can provide you with the funds needed to get your project off the ground, without forcing you to put up your home as collateral. Sometimes called unsecured loans, a personal loan comes with a higher interest rate and most require a minimum credit score. But for those with good credit, a personal loan may still offer lower interest rates than a standard credit card, as well as loan amounts higher than available through most credit cards.
Know your budget
Before applying for a loan, check and double check the plans and budget for your project. Knowing exactly how much money you need to complete the job and keeping everything well organized and easy to access will make the process smoother.
Paying for a large home project is a serious decision, make sure you understand the benefits and risks but know you have options. “The increased ability in the market to tap equity bodes well for homeowners who have been waiting to update their homes,” said Gorman.
For more information on using your home’s equity to pay for projects, visit BankofAmerica.com.
Getting ready to start a major project? How are you planning to finance it? Did you find one of these options better than the others?
Feeling the budget crunch? We have some free tools to help you plan that next project.