Everyone has been in that situation where they have found the perfect new design for their kitchen or have finally decided to take the next step of building a pool but invariably struggle as to how they would fund these projects. Well, the first thing to know is that cash is not the only option. It is great if you can save up and spend. However, in most cases, it is very difficult to spend so much money on remodeling projects. People usually think of a personal loan, although that might be a good option, there are several other alternatives available to you!
Table of Contents
Cash-out Refinance
Cash-out refinance allows homeowners to borrow additional funds when they refinance their existing mortgage. There are certain requirements to qualify for a cash-out refinance. You must have a debt-to-income (DTI) ratio of less than 43%. This means that your monthly debt expenses cannot exceed 43% of your monthly gross income. You also require an LTV ratio of at least 80%, which means you have 20% home equity. Credit scores can play a big role in the refinance rate you receive.
In most cases, lenders would require your credit score to be greater than 620. Refinancing involves replacing your existing mortgage with a home loan with better conditions, usually a lower interest rate. When mortgage rates are extremely low in today’s market environment, refinancing with a cash-out option is an exceptional option. The amount of additional funds that you can borrow is determined by the loan-to-value (LTV) ratio. Most lenders allow up to 85%.
Pros of a Cash-out Refinance:
- A single mortgage payment that includes the refinance
- Low mortgage rates
- Can improve credit score
- Mortgage debt is tax-deductible
Cons of a Cash-out Refinance:
- Home is collateral
- Larger mortgage payment with a cash-out option
- Closing costs of refinancing
Home Equity Line of Credit (HELOC)
Home equity line of credit or HELOC is a viable option for homeowners who have adequate equity in their homes. It’s a loan option that lets homeowners borrow cash by using their home equity as collateral. If you have been building your home equity over time and have more than a 20% stake in your home, then a HELOC can provide a low-cost financing option for your remodeling projects. The maximum amount you can borrow is up to 80% of the home value, following which an outstanding mortgage is deducted. For example, if you have a $500,000 home and your outstanding balance is $300,000, you can borrow up to $400,000 ($500,000 * 40%), therefore, the total amount you are eligible for is $100,000 ($400,000 – $300,000).
HELOC repayments are flexible and are divided into two different stages, the draw period and the repayment period. You can take out funds from the HELOC during the draw period, repay funds, and take funds out again, just like a credit card. There is a lot of flexibility during the draw period as you only need to pay the interest on the outstanding balance and do not need to pay back the total amount borrowed. This can be a great option for individuals who know they will get their income soon but require the remodeling work to be done now. Once the draw period is over, the repayment period begins. During this period, you can no longer access the HELOC and are required to pay back the principal and interest.
Pros of a HELOC:
- Flexible repayments
- Interest payments are tax-deductible
- Low-interest rates
- Lender fees can be removed
Cons of a HELOC:
- Home is collateral
- Variable interest rates are unpredictable
- Risk of overspending during the draw period
Home Equity Loan
Home equity loans, also known as second mortgages, are a loan option where homeowners can receive a lump-sum amount determined by the amount of equity they have in the home. It is similar to a HELOC. The home is the collateral in both cases, but you get a lump-sum amount that functions more like a mortgage rather than a credit card in this loan.
Pros of a Home Equity Loan:
- The lender fee can be waived
- Useful in funding large projects if you have home equity
- Low-interest rates
- Interest can be claimed as a tax deduction
Cons of a Home Equity Loan:
- Home is collateral
- Requires at least 20% home equity
- Closing costs
- It will be a second mortgage payment over your existing one
Credit Card
Credit cards can be a viable option for emergency renovation projects which require funds quickly. You can borrow on a short-term basis and are required to make minimum payments to your credit card account. If you have an outstanding balance beyond your payment date, then interest starts accruing. Credit cards have extremely high-interest rate charges and will not be a viable long-term option for large projects.
Pros of a Credit Card:
- Flexibility in payments
- Spend now pay later
Cons of a Credit Card:
- Very high-interest rates
- Credit card fees
In conclusion, there are several options available for remodeling projects for your home without dipping into your savings. Some low-cost options if you have home equity include HELOC and home equity loans, which can be used to fund large projects as the pay-off period can extend for ten years or longer. If you plan on refinancing because of the low mortgage rates in the market and your remodeling projects are part of the plan, then a cash-out refinance option is the best as it limits your debt payments to a single mortgage payment. Lastly, if you have emergency renovation required, then a credit card can be a viable solution. In any case, always do your research and choose the best alternative that best suits your financial needs in the short and long term!
Featured Image by rawpixel.com
