Financing a Home Remodel
For this guest blog, we asked John Yannetti, Loan Officer at Charter One, to explain financing options for remodeling projects.
There are four main options to pay for a renovation on your home:
This is a good option if you prefer to not hold debt but with interest rates still hovering at all-time lows, you may want to consider borrowing against your property and investing your cash so it’s bringing you a return. Also, renovations can sometimes cost more than originally anticipated so, if you decide to go this route, be sure you have enough liquid funds on hand to pay for any unforeseen contingencies. 10% of your contract amount is generally accepted by the industry as an adequate level of reserves.
Home Equity Line of Credit
If you have enough equity in your property to allow for a loan in the form of a home equity line of credit, this can be an efficient and straightforward approach to drawing funds needed for your renovation. Typically, these loans are set up with a limit equaling some percentage of the current value of your home (typically as high as 90%) and you are given a checkbook to use as needed. If you have an existing mortgage, the HELOC will go to a combined loan to value percentage, taking into account the existing mortgage amount and allowing for additional funds up to a set percentage of the home’s current market value. These loans are usually variable rate, tied to an index such as Prime Rate and can change as the market changes. Fixed rates are available with this structure and there are institutions that offer home equity loans that give you a set amount upfront as opposed to the check writing approach. During the recent refinance boom, many people were able to get very low rates on their primary mortgage and wish to keep that in place. A home equity line or loan allows you to do just that. Current home equity line market rates are between 2.99% and 4.54% and home equity loan rates between 2.99% and 4.84%.
Another way to access existing equity in your home is through a cash out refinance. If you have an existing mortgage with a higher than current market interest rate, an adjustable rate mortgage due for a rate change or if a home equity as described above just won’t work for you then consider a new, first mortgage allowing you to extract cash to pay for your project. Available products for this option encompass a wide range of choices from 30-year fixed at approximately 4.25% all the way down to shorter term ARM’s with rates in the sub 3% range. This loan utilizes the existing value of your property in order to determine how much money you can borrow and the loan to value requirement is typically more stringent than what you may be used to seeing for a standard purchase or non-cash out refinance.
Construction or Renovation Rehab Loan
Construction to permanent or renovation rehab loans are, as the names imply, focused specifically on financing a construction project for your home. The important difference between these products and those described earlier is that construction loans will use the future or as complete (after construction) value of your property as the basis for your loan. In some cases, using future value to calculate how much of a loan you are able to draw will enable you to roll all closing costs into the loan. Utilizing a construction loan makes sense when you need the future equity in your home to pay for the work you are considering. These loans are closed prior to work being initiated, structured as a line of credit and disbursed to Landis Construction as work progresses. As Landis Construction reaches project benchmarks, they will request money from the bank and you will make monthly interest-only payments on the drawn balance. Once the project is finished, your loan automatically converts to the permanent mortgage you have chosen.
Historically, these loans were much more expensive than traditional offerings but that has changed in recent years. We now have the ability to offer a one-time close construction loan and permanent loan package at market rates with no origination or discount Points. This single transaction, reduced cost approach makes these loans more cost effective and appealing than in that past. Another benefit of going this route is that the lender will inspect your project on a regular basis and most customers find comfort in knowing the bank also has a vested interest in the success of their project. These loans also help you manage the potential for cost overruns by allowing for and in fact requiring a contingency reserve be established for changes that may occur. Be sure to seek out a company and loan officer that are fluent in this product line as they are unique and require specific expertise.
What can a homeowner do to prepare financially if they want to do a remodel?
If you are considering a remodel it’s best to engage as soon as possible with a contractor AND a lender in order to plan for all costs and how you will pay for the project. Describing your vision to Landis Construction and allowing them to translate that vision into a preliminary budget is important in making sure your perception of cost will be in line with a professionally developed budget. Once you have a sense for cost and if you’re considering financing your project, speak to a lender who can provide (at no charge) potential financing options for your specific scenario. It’s never too early to speak with your lender as even if you don’t have a firm bid in hand for the work, an upper limit can be used to determine financial feasibility.
The mortgage industry has become extremely detail oriented over the last few years and you should speak with your lender first before making any major financial profile changes. For example, if you’re considering liquidating or moving existing funds, changing jobs, buying a property first with a desire to renovate later or if you think you may have challenges on your credit report, it makes sense to seek mortgage advice. Your lender can counsel you on nuances of the mortgage business that may be important in how your file is underwritten. In some cases, seemingly inconsequential adjustments made to a financial profile could have significant ramifications on ability to qualify.
What information should I have when I meet with a lender?
To prepare for your initial lender conversation, there are certain important pieces of information you’ll want to have at hand. They’ll ask you about the most recent two years of employment, whether you’re self-employed, about your salary/pay plan, how long you’ve owned the subject property, the amount and type of assets you have (including all real estate holdings), your credit score/profile, an estimate of the value of the home today, an estimated cost of construction and an estimated value of the property once the project is complete. Based on this input, your lender can describe the level and type of loan you would be able to attain as well as provide you with an initial quote for closing costs and interest rate. All this can be done via telephone in approximately 30 minutes time.
No matter which approach you choose to pay for your remodel, be sure to invest the time upfront in discussing budget with Landis Construction and, if needed, a lender so you can plot your course efficiently and eliminate the potential for costly and disappointing surprises.