If your home needs repairs and you don’t have the cash lying around to pay for it, you may be eligible for a home improvement loan. As the name suggests, this loan provides funds for your home improvements by taking the money from the equity of your home.
It’s not a first mortgage. In fact, this loan does not touch your first mortgage. It is a second lien on your property or a junior mortgage. There are several ways you can get access to this money, which we discuss below.
The Types of Home Improvement Loans
You have several options when you decide to take out a home improvement loan. Remember, it’s a second mortgage, so this will be a separate mortgage payment that you must make. Your options include:
- Home equity line of credit – The HELOC works much like a credit card. You borrow a specific amount of funds and they sit in your credit line. The lender provides you with a checkbook or debit card to access the funds as needed. You pay interest only on the funds that you withdraw, with the option to pay back principal if you want. Any principal you do pay back, you can reuse for the first 10 years. After the 10 years is up, you then make principal and interest payments over the next 20 years to pay off the loan.
- Home equity loan – This is also a second mortgage, but you receive the funds in one lump sum. You are then free to do what you want with them. Many people put the money in a savings account and use the funds as needed. You do not get the chance to reuse the principal and you must make principal and interest payments over the course of the loan’s term.
Refinancing Your First Mortgage
If you have a sizeable amount of equity in your home, you may refinance your first mortgage as a cash-out refinance. The amount you borrow over the outstanding principal balance of your current mortgage can then be used for your home improvements.
Cash-out refinances often have tougher restrictions than home equity loans or lines of credit. This is because you are taking out a larger first lien, so the lender is at higher risk of default. Generally, to secure a cash-out refinance, you need good credit, a low debt ratio, and you can only borrow up to 80% or 85% of the home’s value.
Other Options for Home Improvement Funds
If you don’t want to mess with your home’s equity, you can tap into a few other options to get the money you need for home improvements.
- Small improvements – If the changes you are going to make are minor, you can consider using a credit card. The interest rate might be rather high on the money borrowed, but if you don’t borrow a lot, you can repay it quickly, minimizing the interest charges. This will save you from having to pay any type of closing costs, which any mortgage will incur.
- Unsecured loan – If the changes are more expensive or you don’t have the credit line on a credit card to fund the changes, an unsecured loan works well too. Again, you’ll likely pay higher interest rates than you would on a mortgage, but you won’t have the high closing costs that make the loan more expensive.
The option you choose for your home improvement loan depends on your situation. Will the improvements increase the home’s value? If so, a mortgage loan can be beneficial. If the improvements are minor, leaving your home’s equity alone might be the better option since it will take a while to gain that equity back with minor changes to the home.Click to See the Latest Mortgage Rates»