Smart Borrower Blog

Financing a Remodeling Project

Oct 23rd, 2007 @ 4:32 PM by MortgageMentor

If your remodeling or addition project is extensive, you may be wondering where the funds will come from. It is much easier than most people realize to get financing for a home upgrade–especially if you already have equity in the property. You may have equity because you have paid the mortgage down, or you may have it simply because the value of the house is higher than the amount you owe.

The easiest way to get financing for a large remodeling project is by taking out a second mortgage on the home. You can choose between a home equity loan and a home equity line of credit. What is the difference between them? The main difference is that with a loan you have a closing and receive all of the money at once; with a line of credit you can make “draws” and take out the money as you need it, so you save a little in interest.

Your home serves as collateral on both types of loans. This is something people should not forget–if you over-borrow, you could end up losing your home! So be sure that you can afford the payments on both your first mortgage and the new loan.

The Application Process

A home equity loan will require an application (and an application fee). It also requires that an appraisal be done on your property, although sometimes you can borrow against your home without the appraisal. One home that went into foreclosure–that was worth less than $20,000–had over $84,000 in home equity loans!

Your loan will depend on the value of your home, the loan to value ration, your income, and your credit rating. The house payment plus your other debt should fall below 36 percent of your gross monthly income. For credit that is less than perfect, you may have to pay extra points in order to get the loan.

Most home equity lines of credit offer a variable interest rate. That means it changes with the prime rate and will be offered as that index plus a margin. Variable rate plans must have a cap, or limit, on how much the interest rate can increase over the life of the loan. Be sure to find out how high your cap rate is, as well as whether you can convert the variable rate to a fixed rate later on.

The interest on home equity loans is usually tax deductible–it depends on your personal financial situation, so check with your tax advisor to be sure.