How to Finance Your Renovation, Part II

Today we continue our five-part series to help guide you through the process of financing your home renovation.

 Previous parts are here:

 Part I

 Here are some of the financing options available to you:

 Pay Cash

If you can afford it, the best financing is no financing at all! Not having to pay back interest is certainly a nice incentive, isn't it? Even if you don't have that kind of cash on hand, it's something you can work towards by cutting your expenses over time.

Systematic Savings

Another way to finance your renovation is to engage in systematic savings by setting up banking systems to automatically set aside a certain amount per week into a separate savings account. If you can work enough savings into your overall budget, it's possible to save up the total you'll need within a year.

The benefit of this plan is that you won't need a loan or use credit to pay for your renovation. We advise against dipping into any emergency funds or retirement-earmarked TFSAs to build this account. And given that you'll be subject to a tax bill, withdrawing from an RRSP is not the ideal way to help fund this account, either.

It's a good idea to research ways to help you save or even make money to help finance the renovation. For instance, earmarking any tax refunds towards this goal is a great place to start.

This plan is ideal for those that want to upgrade their house without actually taking on any debt. If you set goals with target dates to keep you motivated, you might be surprised how much you can save over time with this approach.

Mortgage Brokers

A mortgage broker has access to boatloads of loan programs, so they can offer you one that's tailored to fit your situation. This is a great place to go if your credit history is spotty.

HELOC

A Home Equity Line of Credit (HELOC) is a very popular method of renovation financing, provided you've established at least 15 to 20 per cent equity in your house. Secured by your home equity, you borrow funds (with a preset limit) and pay the principal and interest (variable rates) back in monthly installments. And given that you can pull money from this multiple times, it's almost like turning your home into a credit card.

Many consider this the most cost-effective method if you need to borrow money to finance your renovation. It's especially so for those with little savings on hand, but a good amount of equity built up in their home.

With a HELOC, you can pull funds when needed over a period of between five and 10 years and have a repayment period of up to 20 years. Note that once the repayment period begins, you can't take any more money out until it's paid back. But the beauty here is being able to borrow again and again up to the credit limit -- without needing to apply for a new loan.

The benefits of a HELOC include monthly payments, flexibility and lower closing costs. The money is always available and can be used for projects other than a renovation. Given that renovations will often involve unplanned expenses, a HELOC is also attractive because you can withdraw any amount to cover these unforeseen events. Overall, this is a highly convenient way to go, and one that we advise considering if you expect your project to stretch out over the course of several months.

Also, pretty much all banks, credit unions, brokerage houses and finance companies offer this type of loan. And perhaps the best part is that in this instance, financiers can usually loan you more money at a lower cost. Interest rates for a HELOC tend to be the bank's prime rate plus one percentage point. As a bonus, there are no closing costs associated with this type of financing.

Do note, however, that there is a downside, too: HELOCs usually have the highest variable rates (although it may be possible for a mortgage broker to get you a better rate -- but check to ensure the broker won't charge you fees directly). Also, you really need to stay on top of payments and pay back some of the principal to lower your long-term debt; if you're only paying the minimum each month and opt to borrow more from the line, your debt can quickly escalate out of control. So it's advisable to stick to your planned purchases when borrowing from a HELOC, especially since banks are prone to offer you more than you need.

In light of this, it can be prudent to actually ask your lender to impose a financing limit. At the very least, you need to be disciplined enough to pay off more than just the interest and to actually cut into the principal each month.

The credit lines, fees and interest rates for HELOCs can be very different from lender to lender, so be sure to do your research.

Pro Tip: Set up your HELOC prior to beginning the renovation. If you do it the other way around, you may find yourself boxed in to the type of loan the bank can provide.

In Part III of our series, coming soon, we'll discuss another pair of popular financing options.