What Type of Loan is Better for Home Repairs and Renovation?
Are you considering making home improvements? Are you worried about financing those improvements? Your home is tappable equity that can provide you the cash you need to increase your home’s value. However, selecting the right type of loan for your needs can be confusing.
This article explains what home equity loans, lines of credit, and second mortgages are, what risks may be involved, and what you can do to make the money last.
What is a Home Equity Loan?
A home equity loan allows you to borrow against your home’s equity or the difference between its value and any mortgages on the property. This type of loan can be easier to qualify for than other loans because your home is placed as collateral.
Home equity loans come in two forms: a home equity loan and a home equity line of credit (HELOC).
If you opt for the home equity loan, you’ll be given cash that amounts to the equity of your home, and you will repay it over a span of 5 to 30 years. These payments have fixed interest rates, and with each monthly payment, you’ll be reducing your loan balance and interest costs.
You could also be approved for a home equity line of credit (HELOC). The HELOC functions like any other line of credit; instead of owning the entire value of your home plus interest, you can borrow what you need from a limit that is based on your home’s equity.
Access to funds is limited to a draw period, usually about 10 years, which is then repaid for a period of around 20 years. Interest rates vary throughout the length of the HELOC.
The HELOC is the most flexible option because you have to control your loan balance and, subsequently, your interest costs; you pay interest only on the amount that you withdraw.
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Second Mortgage?
Have you been confused by the term “second mortgage?” Are you wondering if it differs from a home equity loan? Surprise! They’re the same thing.
The term “second mortgage” is most often used when the homeowner already has a first mortgage on their property that hasn’t been fully paid off. Often, the first mortgage is the loan that was used to purchase the property.
Homeowners can use additional home equity loans, or second mortgages, to borrow against the home if it has accrued enough equity. Payments are made every month on top of payments to the first mortgage, hence the term “second mortgage”
Are There Are Risks?
Like any line of credit or loan, there are risks involved, but with a HELOC or a home equity loan, your home is on the line.
Second mortgages or HELOCs use your home as a guarantee against your loan. If you have trouble paying your HELOC, your lender can freeze or cancel your line of credit. But if you default on your loan or HELOC, the bank could foreclose on your house.
How to Find the Best Rates?
Home equity loans, both lump-sum and HELOC, are partially based on how much equity you have on your home.
Equity is calculated by determining the difference between the value of your home and how much you owe on any mortgages.
For example, imagine that your house is valued at $400,000. When you purchased the home, perhaps you made a down payment of $80,000.
You have also paid down $20,000 in mortgage principal. Because you still owe $300,000 on your home, you would have $100,000 in equity.
The lender will determine the amount of the loan or the credit limit and the rate of interest by looking at your home’s equity in combination with your credit score and income.
Second mortgages or home equity loans and some HELOCs require closing costs, which can range between 3% and 6% of the total amount of the loan.
It’s important to shop around for different offers because the closing costs and interest rates can vary.
You can get loan estimates from several different sources, including a local loan originator, an online or national broker, a bank, or a credit union. Make sure to carefully read all conditions before signing your loan.
Make That Money Last
It is best to weigh your options by sitting down and understanding where you are at financially.
Whether a home equity loan or a second mortgage is right for you and your home improvement project.
If you haven’t already paid off your first mortgage, make sure that you can afford a second mortgage. It is also important to save up and work into your home improvement expenses. Also, keep in mind that payments can increase over time if you have a variable rate.
With a home equity loan, you can move any sitting money to an interest-bearing account while you’re waiting to spend it.
This will help you earn back some money that will be spent in interest. Importantly, the interest you pay on loans and HELOCs is tax-deductible if the money is used to remodel or repair your home. Get a loan for repairs can make it easier to get home projects done.
Because it may be difficult to determine which option would work best for you, it may be worthwhile to meet with a financial adviser to help you navigate the decision-making process.
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Are There Any Alternatives?
If you decide that a second mortgage or HELOC is not right for you, you may want to consider personal loans, credit cards, or cash advances.
Personal loans can be an option when you haven’t accrued much equity in your home.
This type of loan can be unsecured or secured. Unsecured personal loans do not require collateral but will carry a high-interest rate. A secured personal loan requires an asset, like a car or a motorboat, as collateral to secure the loan.
Credit cards may also be the right choice for you. Credit cards do not need collateral and could offer enough cash for smaller home improvement projects, like the remodel of a bathroom. Moreover, you can avoid the closing costs of a HELOC or a home equity loan.
However, interest rates may be higher.
Lastly, a cash advance may be useful for short-term emergency money. This type of loan has the highest interest rates, and the need for collateral is dependent on the lender.
SUMMARY
Improve the value of your home through home remodeling or repair is a great way to retain the property value.
However, this is not always cheap. A loan or a line of credit against the equity of your home may be the best way for you. However, it’s important to lay out a clear and detailed financial plan. This will ensure that you will not risk losing your home while you are trying to fix it up.
Once you’ve made the decision to apply for a HELOC or second mortgage, stick to your financial plan and use the loan as intended. At the end of your home improvement project, you’ll see your property value increase, and your home equity loan will have paid off.
Published August 9; Updated November 14, 2019.
