How to Finance Your Home Improvement Project

How to Finance Your Home Improvement Project

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Undertaking a home improvement project can be a daunting task, with the homeowners working closely with their architect to discuss what they would like to have done for their most valuable asset. Blueprints need to be drawn up, a contractor hired and licensing acquired before the work can be started. In some cases homeowners need to secure neighbor approval or appear before the town planning board to submit plans.

mortgage balanceBut even before the project gets going, financing has to be in place. Unless you have cash on hand to cover what will likely cost you tens of thousands of dollars or more to complete, you’ll need to do what most people do: borrow money.

Your Choices

Essentially, you have two choices when it comes to paying for your project: refinance your first mortgage to include the cost of your home improvement project or tap your home’s equity in the form of a home equity loan (HEL) or home equity line of credit (HELOC).

The first choice, mortgage refinancing, can mean you approaching your current lender or seeking out a new lender to offer new financing. If you go with your current lender, you may be able to save on closing costs—he already knows you or she may waive certain fees.

If you decide to work with a new lender, compare the rate offered including fees to see what your costs will be. You may be able to shave an eighth of a point off of your mortgage, but end up paying more in the long run if your closing costs are higher. In any case, the Federal Reserve Board advises consumers to shop around and be prepared to negotiate the terms of the loan.

Your Plans

Be prepared to present your home improvement plans to your banker, outlining the work to be done. Your banker can determine what your home’s worth will be after the improvements have been completed and qualify your loan accordingly. You’ll end up with one monthly payment instead of two by selecting the mortgage refinancing option.

The second choice, tapping your home’s equity, is ideal if your first loan offers you satisfactory terms. You’ll stay with your original lender, but you’ll take a portion of your home’s equity and use it for your project.

You can choose a HEL or HELOC and decide whether you want to work with your current lender or use someone else. With a HEL, the amount you take out is fixed while with a HELOC you obtain a line of credit, tapping it only as needed. MSN “Your Money” columnist Liz Pulliam Weston says about HELOCs: “You’re given a credit limit that you can borrow against, and paying down your debt frees up more credit that you can potentially spend. Home-equity lines of credit have variable interest rates that are typically tied to the prime rate.”

Your Decision

Both options offer tax advantages to you. Consider discussing your options with your financial adviser who can discuss the best course of action for you, tax advantages, possible tax breaks and implications of higher property taxes once your municipality reassess your home.

Be prepared to pay more for homeowners insurance too. There are additional costs you will incur beyond the home improvement itself, which means that any project should be evaluated to include those aspects as well.

Resources

Federal Trade Commission: Home Equity Credit Lines

MSN Real Estate: 5 homeownership tax myths

Adv.SayLending.com offers free smart lending guides for decision making, tools to help you find the right loan for your needs.

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