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How to Finance Your Renovation, Part III
Today we continue our five-part series to help guide you through the process of financing your home renovation.
Previous parts are here:
Here are two other very popular financing options available to you:
Home Equity Loan
With a home equity loan, you'll receive a lump sum against your home equity (this means the difference between what is still owed on the mortgage and the home's current value). It's a secured loan that generally has a fixed interest rate, repayable over 15 or 20 years. Typically, you'll need at least 15 to 20 per cent home equity to be eligible for such a loan, and the terms will vary based on household income, credit scores and your past performance paying down debt. Given the number of lenders that feature such loans, you'd be advised to shop around to try to secure the best terms you can.
A benefit of this route is that you'll be able to access money as required at lower interest rates. And because home prices have soared lately, you may be surprised how much financing is available to you with this option. It's a great choice if your project is quite expensive, it's one that's rather easy to get and, as a bonus, this type of loan is tax-deductible when taken out specifically for a reno.
Also, you won't pay interest on funds that you aren't using right away.
Just remember, this is essentially like a second mortgage, so you better be able to make your payments or risk foreclosure. In this, expect slightly higher rates than you'd get with a regular mortgage.
Cash-out Refinance
If you have a good deal of equity in your home, an alternative financing option to a home equity loan is a cash-out refinance. In this instance, your current mortgage is paid off completely and replaced with a new and bigger mortgage, with the difference in cash going directly to you. In such a plan, a bank will generally let you access up to four-fifths of the value of your house, so you'll be left with 20 per cent equity.
The biggest advantage of this type of home equity loan is that you'll generally get the lowest interest rate possible, but of course, the actual loan terms will vary based on what your home is worth, your income and your credit score. Some banks offer loan options that allow you to divide the mortgage into portions, making it a snap to track how much cash you used to pay for the reno.
It's also convenient because instead of having separate mortgage and loan or line of credit payments, it's all rolled into your new mortgage payment. Another plus is that this type of loan is pretty easy to qualify for.
This option is best employed when the work done will add value to your home, as it improves the likelihood that you'll get a better ROI if you decide to sell the house down the road. As a result, this is the ideal option for those considering big projects or an expansion.
If the renovation is not going to add value, you may want to finance it in another way.
Mortgage renewal time is perfect for thinking about this type of financing, because if you refinance mid-mortgage, you could end up with some major fees to pay. Now, even with those fees, depending on your new rate, you could still be ahead of the game, but this is something that needs to be calculated for each specific case.
Two other pros for taking this route: (a) the loan is spread out over a longer period of time, so the payments are smaller; and (b) you won't cut into your savings, cash on hand or emergency fund.
This is a perfect option for homeowners that tend to be spenders given that you won't need the same level of discipline to pay this back that other types of loans require.
Do note, however, that closing costs for this financing tend to be higher than for a HELOC.
In Part IV of our series, coming soon, we'll discuss the final few available financing options.