Whether you’ve just bought a fixer-upper and need to do some renovations, you’re trying to make room for a growing family, or you just want to increase the value of your home by remodeling, you have several options for financing the improvements. Before you approach a lender, make a detailed plan of the work you want done and get bids from several contractors. Whenever you use your home as collateral, as in a mortgage or home equity loan, you risk losing it if you can’t make the payments. That’s why it’s so important to get detailed, accurate cost estimates from reputable, experienced contractors. If the contractor’s work is incomplete or shoddy and you have to hire someone else to finish or fix it, you still have to repay the loan.
Shop for financing at established financial institutions and compare rates and fees from several different lenders.
Contractors sometimes offer to arrange financing with a particular lender. Avoid this; it’s almost always a bad idea. The contractor usually receives a commission from the lender for the referral, and you can end up paying for it in higher interest rates or fees you wouldn’t incur at your local bank or credit union.
Ask friends, neighbors, and coworkers who have remodeled or made home improvements that you like. Find out whether the contractor was responsive, stuck to deadlines, and addressed concerns quickly and completely. Once you’ve identified several possible candidates, check them out with the local Better Business Bureau or consumer protection agency to see if they’ve had complaints filed against them and, more importantly, whether they resolved any problems satisfactorily. The Angie’s List website (www.angieslist.com) is another good resource for finding reputable contractors in your area.
Get at least three detailed written estimates that spell out exactly what will be done, the type and quality of materials that will be used, and the cost, based on your written description of your project. Compare the bids carefully. Don’t automatically choose the lowest bid without discussing each bid with the appropriate contractor so you can determine why they differ. If a bid is significantly lower than the others, you may want to toss it out. The contractor may be bidding inferior materials, planning to take labor-saving shortcuts that compromise the quality of the work, or doing a “bait and switch” where he increases the price once the work has already begun.
Contractor Fraud
Before hiring a contractor to build or renovate your home, educate yourself about contractor fraud so you know what to look out for. Visit www.homeadvisor.com for information on popular contractor scams and advice on finding and using reputable contractors.
Once you’ve chosen a contractor, ask for the name of his insurance agent and call to verify that he carries workers’ compensation insurance and coverage for property damage and personal liability in case of accidents. You don’t want to be held financially responsible if a worker is hurt on your property. It’s also a good idea to call your state and local government and find out if contractors have to be licensed or bonded. If they do, check to make sure the contractor has complied. Make sure the contractor has also obtained all necessary work permits; if the contractor says those aren’t necessary, go with someone else.
Never pay a contractor the entire cost of the project up front. He’ll probably request a down payment, the amount of which may be limited by state law. Try to keep the first payment to no more than one-third of the total job cost. Additional payments should be tied to completion of measurable milestones, so you’re paying for the work that’s actually been accomplished. Include these milestones in your contract to ensure that your contractor understands and agrees to them. You should be holding at least 15 percent of the contractor’s money until the job is finished to your satisfaction and you have written proof that all subcontractors and suppliers have been paid.
It may be that you’re not interested in improving your home but in building it yourself. This is a huge undertaking and will require a commitment of time and money.
The two most common methods of financing home improvements are cashing out the equity in your home by refinancing and taking out a second mortgage or home equity line of credit (HELOC). Either way, you are borrowing money with your home as collateral, which reduces your equity stake and may put your home at risk (especially if housing prices decline). Home equity loans, a type of second mortgage, have a fixed term, usually between five and fifteen years, at a fixed-interest rate. You borrow one lump sum of money and make regular monthly payments over the life of the loan.
Debt Consolidation
Debt consolidation is the number one reason people use home equity loans. The loans are commonly used to pay off credit card and other consumer debt or to make home improvements. Always use caution when borrowing money against your home—you could lose it.
Home equity lines of credit are a type of revolving credit, like a credit card. They usually come with twenty-five-year terms split into two portions: the drawing period (where you borrow money as needed) and the repayment period, and they usually come with variable interest rates (rates that change periodically). You’re allowed to borrow a certain amount over the drawing period of the loan, and you don’t have to borrow it all in a lump sum. Some lenders give you special checks; others provide a type of credit card that you use to access the money. As you pay down the amount you’ve borrowed, you can borrow it again. For example, let’s say you have a line of credit of $15,000. You borrow $6,000, leaving $9,000 of available credit. You pay back $3,000, making your available credit $12,000 ($15,000 – $6,000 + $3,000 = $12,000). The interest rate on HELOCs is usually variable, so your payments change depending on the current rate and your outstanding balance. At the end of the loan term, some HELOCs require you to pay the full unpaid balance; others amortize the balance over ten to fifteen years. If you sell your house, the balance is due at the time of sale.
Home equity loans are best suited for times when you need a lump sum amount. Lines of credit are best if you need the money at intervals, so you borrow only the amount you need, when you need it. Lines of credit can be dangerous if you have trouble controlling credit card debt because they work in much the same way as credit cards. But there’s one very important difference: With a home equity line of credit, your home is at stake. If you get in over your head, you could lose your home.
Home equity loans are attractive because their rates are higher than interest rates on first mortgages but much lower than credit card interest rates. Interest on home equity loans may also be tax-deductible. Closing costs for home equity loans are similar to those for first mortgages. Expect to pay 2 to 5 percent of the loan amount.
The Limits of APR
You can’t use the APR to compare home equity lines of credit and home equity loans. Interest rates on HELOCs are normally variable, plus the APR for a line of credit may not include fees and closing costs, so it could be misleadingly low if you try to compare it to the APR for a home equity loan.
A large percentage of mortgages are now done online. Lenders who offer the most competitive rates tend to be online. You will probably be able to track the progress of your loan online. At the very least, you can use the Internet to educate yourself quickly and painlessly about various mortgage products and current rates.