To improve or not to improve? There’s no question that new cabinetry would help your tired kitchen, or that an expanded family room would come in handy. The real quandaries for many homeowners are more pragmatic: How am I going to find the money to pay for my domestic dreams? And how will the expense affect my personal financial situation?
Finding the money is likely to be much less of a problem than in the past: There are more types of loans and sources for remodeling financing than ever before. To help you pick the best route of financing for you, we’ve put down the options, with comments on when they may be appropriate.
Put it on plastic
Home center stores–retailers that sell a wide range of home improvement products and even often provide labor and installation services–typically allow a customer to put the whole tab on his or her bank credit card. “You can charge for the work itself as well as the product,” notes Jerry Shields, spokesman for Atlanta-based Home Depot stores.
Pulling out plastic is a convenient solution for relatively small remodeling jobs, notes Walter Stoeppelwerth, publisher of HomeTech Information Systems, Bethesda, Md. But if you’re planning a big-ticket job, your credit card limit may not be high enough to cover the entire tab. What’s more, interest rates on credit cards are typically higher than rates on the home equity loans and other financing sources. Experts say homeowners should carefully shop the financing options for any large sums that will take time to pay off.
Home equity
Especially if you’ve been a homeowner for a long period of time, chances are you’ve built up substantial equity that lenders are happy to take as security against a loan for home improvements–or any purpose, for that matter. Equity is defined as the appraised value of your home, minus any mortgage debt you have on the property. That means that if an appraiser says your house is worth $200,000, and you have just $80,000 left in principal due on your mortgage, you’d have $120,000 worth of equity.
Home equity lending has mushroomed in popularity, says Stoeppelwerth, and today that’s the type of financing most homeowners use to pay for an improvement. Indeed, personal finance experts say that renovating represents a prudent use of equity borrowing, because the improvement is likely to boost the value of your home, and you’ll have something to show for the money you are spending–even 10 years from now when you might still be paying off the loan.
Still, lenders don’t scrutinize whether you can afford to pay back an equity loan as carefully as they examine your ability to make payments when they are granting a regular mortgage loan. Catherine Williams, president of Consumer Credit Counseling Service of Greater Chicago, advises: “Take a long-term look at whether you can really afford this improvement. It doesn’t matter if it will boost the value of your home, if you can’t budget in the payments.”
It’s also important to note that if you default on payments on your equity debt, lenders could start foreclosure proceedings, just as they can if you miss regular mortgage payments.
Home equity financing comes in two basic varieties. One is the “line of credit” in which a homeowner is given a checkbook and allowed to write checks up to his or her borrowing limit. The other is the equity loan, in which the homeowner is advanced a set sum, and must pay it back in monthly installments, much like a mortgage loan. Lines of credit are more popular, and may be more appropriate for remodeling jobs, where a homeowner must write a variety of checks to pay for product, labor, etc.
Lenders often compete aggressively for equity business, notes Keith Gumbinger, vice president of HSH Associates, a Butler, N.J., mortgage information service. “Most lines of credit have a variable interest rate, which is tied to the prime rate,” he notes. “If you shop well you may be able to find a line at prime plus 1 percent that is available with no points or application fees.”
However, those who have a shaky credit record will not qualify for the lowest interest equity loans or lines, notes Peggy Cortright, regional manager of Mortgage Market Information Services, Paoli, Pa. And although equity loans are not as popular, Cortright notes that the interest rate on loans is usually somewhat lower than the rates on equity lines.
The interest on any equity loan or line is tax deductible as long as the equity loan doesn’t exceed $100,000, notes Chris Wheaton, manager in the personal financial planning group of the Chicago office of Arthur Andersen. However, homeowners can deduct the interest they pay on equity credit even when the loan amounts exceed the $100,000 limit if the funds are used for home improvements.
The 100% solution
In a standard equity financing arrangement, lenders will advance you cash using up to 80 percent of the equity you have in your home as collateral. If, for instance, you have $30,000 in equity on a home worth $100,000, you can usually receive up to 80 percent of that $30,000, or $24,000. But with a 100 percent equity loan, you’d be able to borrow the whole $30,000. These loans are especially attractive for homeowners who have recently purchased their home, because if you made just a 10 percent down payment, you may still be able to tap your equity.
Although in some markets 100 percent equity loans are hard to find, “you can find them from several lending sources in the Chicago market,” notes Craig Hesselberg, loan officer with American Home Finance in Palatine. If you are seeking such a loan, says Hesselberg, don’t expect to receive the nod from a lender unless you have a decent credit record. Rates on the 100 percent lines range from prime plus 5 percent to prime plus 8 percent, depending on the strength of your credit standing, says Hesselberg.
FHA Title 1 loans
“With this loan, you can get up to $25,000, and no equity or appraisal is required on your home,” explains Herb Moses, director of housing initiatives for the HomeStyle program at the Federal National Mortgage Association (Fannie Mae).
“If you could qualify for a home equity loan, you’d probably choose that over a Title 1 loan,” admits Moses. These loans do carry a variable rate that is about 3 percentage points higher than competitively priced equity loans, adds Stoeppelwerth. Lenders will grant these loans based on how they judge your ability to repay; they don’t like to see the payment on the loan and all of your other regular monthly debts totaling more than 45 percent of your gross monthly income, or income before taxes, says Moses. Borrowers must also present a lender with a contractor’s writeup and plans for the improvement. (Call 1-800-733-4663 for more information about Title 1 and a list of area lenders offering the loans.)
Contractor connections
Increasingly, notes Stoeppelwerth, the remodeling firm that pitches a plan for your new kitchen or other improvement will also offer to provide financing. In most instances, the remodeling firm has a relationship with one or more lending firms, and acts as an intermediary between the borrower and the financing source. When a lender is familiar with the track record and performance of a contracting firm, he is often more willing to lend, notes Seymour Turner, general manager of Airoom Architects & Builders, Lincolnwood, whose firm has its own mortgage brokerage subsidiary.
HSH’s Gumbinger agrees that securing financing through a contracting firm can give the lender and the borrower some added security that the remodeling firm will indeed finish the project properly. But Gumbinger adds that homeowners should still shop the loan market before obtaining financing through the middleman. “Some contracting firms will add on points or otherwise take a profit on the loan.”
Chicagoan Jaye Quadrozzi shopped the loan market before selecting an equity loan offered through her contractor when she recently remodeled her kitchen. One of the advantages of securing her loan from the subsidiary of the same company doing the remodeling was that “I knew exactly how much money I needed for the remodeling,” says Quadrozzi. “They gave me an exact figure for the job, and my loan was for that amount.”
