If you own a home, you likely have a long list of projects. An infinity pool may be your fantasy, but updating cabinets and installing new fencing might fall in the necessity category. Using cash for improvements is ideal, but if you can’t fund upgrades out of pocket, there are several potential solutions to improve your home.
Homeowners spent lavishly in every state on home improvements in 2018, with California alone exceeding $20 billion in expenditures according to data from the National Association of Homebuilders.
Even if you have a mortgage, if your credit is good and your home is not excessively leveraged, you can access capital with a home equity loan or home equity line of credit (HELOC). Alternatively, you may consider refinancing your home if rates are lower than for your existing loan. With a cash-out refinance, you have the potential to reduce your monthly mortgage payment in addition to receiving cash so you can complete that long list of home projects.
Unsecured home improvement loans
An unsecured loan does not require collateral. A traditional home equity loan will be priced as a function of three variables: the amount of the loan, the term, and your credit score. The downside to a traditional loan is that it may carry a higher interest rate. On the flip side, an unsecured loan can require less documentation and the closing fees can be lower relative to a mortgage or HELOC.
Refinancing as a source of home improvement funds
The vast majority of mortgages allow you to prepay your loan at any time without penalty. This is enormously important relative to how interest rates are trending and paying attention to interest rate forecasts. Seizing the opportunity to refinance when mortgage rates have dropped below your current rate can generate significant monthly savings.
But if you need to access to a larger amount of capital for improvements, it may be necessary for you to research a cash-out refinance. This is a refinance that generates a surplus amount over your present mortgage balance, in effect leaving you with a cash balance that is typically not taxable. Of course, you are free to use the funds for any purpose, it doesn’t have to be just home improvement.
One essential aspect of any refinance is that it may entail the same amount of documentation as when you originally purchased your home. Despite the fact that you may not have to pay out-of-pocket for costs like an appraisal, lender legal fees, lender points (fees) and recording fees, these items will be netted out of the loan proceeds.
Some financial advisors recommend that you analyze how long it will take to recoup closing costs based on your payment savings to gage whether refinancing is worth considering. One suggested rule is to target an 18-month period. Typical closing costs for refinancing are in the 1-1.5% range.
If you are considering a home equity loan or HELOC to improve an investment property, it makes sense to analyze the return on investment (ROI) for the transaction. For example, if you borrow $30,000 to improve a rental unit that will generate an additional net income of $500/month or $6,000/year, the payback is five years and the annual ROI is 20%.
Different types of loans
In addition to conventional loans, there are variable rate products available for home equity loans and HELOCs. A HELOC is essentially like a credit card in that interest is only due on the portion of the line that is drawn down. Some HELOCs will have minimum draw requirements. Bear in mind that floating rate loans often have lower initial rates, but the borrower is at risk for upward adjustments based on an index (typically a U.S. Treasury bill) and the stipulated spread above the index expressed in basis points (bps). One basis point is equal to one percentage point.
First Centennial Mortgage provides conventional, FHA, and VA home and renovation loans. Our team of loan professionals looks forward to working with you on your home improvement and housing finance needs. Contact us today!