If you are thinking about home improvements, you likely have many financial questions. Big improvements are a big investment. Here are some of our best tips for your home improvement loan.
Should you finance your home improvement project?
If your home improvement project costs you more than you can pay in cash, financing is available. First, think about how long you will need to pay off the loan amount. If it is a period of 12 -18 months, most new credit cards have a 0% financing introduction rate. A credit card is an excellent way to finance your project if you can pay off the home improvement loan within that time frame. However, make sure you pay it off before the promotional period is over. Most credit cards will add all the interest you would have paid over the promotional time frame if you don’t. If the project costs more than what you can pay off in a short time, then a home improvement loan or a home equity loan are excellent options. Both will allow you to have a sensible monthly payment for an extended amount of time.
What is a home equity loan?
In essence, a home equity loan is a second mortgage on your home. It is usually for sizable home improvements that are costly. A home equity loan is for a fixed amount placed against the homestead. Also, it often offers an extended repayment term, more so than an unsecured loan. Money Federal Credit Union currently has a loan term period of up to 10 years. A home equity loan will typically allow you to borrow up to 90% of your home value. In other words, 90% of the appraised value is your maximum loan amount. If you still owe money on your mortgage, or already have a home equity loan, the lender would subtract that amount from the 90%.
For example, With a paid-off mortgage, if your home’s appraised at $100,000, you could borrow 90% of that, which is $90,000. Let’s say you still owe $50,000 on your mortgage. You would need to subtract that $50,000 from the $90,000. In this case, you could borrow $40,000. You may also hear the term loan-to-value ratio. This term defines the ratio banks, and credit unions use to determine their level of exposure to risk when lending.
On top of being able to borrow more money with a home equity loan, the interest rate and payments are often lower than an unsecured loan. The repayment period is usually longer because your home secures the home improvement loan. If you fail to pay the mortgage and go into default, the bank will foreclose on your home. Using the home’s equity is a great way to pay for larger home projects and still have an affordable monthly payment. You also may be able to deduct the interest paid on a home equity loan when you file your taxes. Keep in mind that the home equity loan process is longer than an unsecured personal loan. There are many moving pieces to this type of loan, including the appraisal and closing.
What is a home improvement loan?
A home improvement loan is another financing option when you’re looking to do work on your home. It is an unsecured loan. Therefore, you are not using any of the home’s equity. That also means your interest rate will usually be higher than a home equity loan because it’s not secured. The amount you can borrow and the loan term is typically lower since the bank is taking on more risk with an unsecured loan. A benefit of this is if you’re a new homeowner without any equity yet, you can still complete home projects. A home improvement loan is also excellent for smaller projects. An unsecured loan is usually approved much quicker than a home equity loan. You can start your project sooner and not deal with an appraisal or have to pay closing costs.
Should you use a personal loan for home improvement?
If you have smaller projects that don’t cost as much, a personal loan may work for you, and you won’t use the equity you’ve built in your home. The interest rates on a personal loan are based on your credit and, therefore, often higher than interest on a home equity loan. The rate increase is due to it being an unsecured personal loan with nothing securing it. Unlike a home equity loan, your home is the collateral if you don’t repay the loan.
If you decide to use a personal loan, the amount of money you can borrow, and your interest rate will vary based on your credit. Good credit typically means a lower interest rate and that you can borrow more. If you have bad credit, you may still be able to get a loan. Generally, the amount you can borrow will be lower, and the interest rate higher. The payback period for a personal loan is typically two to five years considering the loan amounts are often smaller than home equity loans. Money FCU offers many different personal loan options to fit your needs. Not one loan type fits everyone’s individual needs.
Don’t have enough home equity yet to fund your big improvement or repair project?
Lenders have stringent loan-to-value and debt-to-income qualifications. If you don’t have enough equity in your property, you may not be able to get the loan. There are plenty of loan options still available to you, but the cost may be higher. Personal loans don’t consider your home’s equity but often determine your annual percentage rate with your credit score. As we said before, bad credit history and a low credit score may mean a higher interest rate. In this case, we would suggest saving up cash or using what you currently have saved and combining it with a smaller home improvement loan. Finally, there is also the option of a credit card for smaller projects. Credit cards are a good option when you are looking to borrow a smaller amount and repay it quickly.
Know the different loan types available to you and the pros and cons of each. Here are your basics.
Home Equity Loan:
- Fixed interest rate
- among the lower interest rates available
- lump sum draws for home improvement projects
- fixed payments
- term up to 10 years
- closing costs
- 4-6 week process
- a lien against the home
HELOC (Home Equity Line of Credit):
- Adjustable interest rate (Note: Considering the length of the loan, an adjustable-rate may start lower but could climb throughout the term of the loan, rising and falling with the market.)
- a low interest rate to begin with but the rate will vary over the term
- draw money out as needed
- loan term up to 25 years
- closing costs
- 4-6 week process
- a lien against the home.
Personal Loan or Home Improvement Loan:
- Fixed interest rate
- often a higher interest rate
- fixed payments
- no closing costs
- a quick approval process
- loan term up to 5 years.
- Adjustable interest rate (although some Credit Unions will offer a fixed interest rate on their credit cards)
- low or 0% introductory period followed by a high interest rate
- flexible payments
- no limit on the payment term period but recommended to pay it off in the promotional period
- typically quick application and approval process.
Are you looking for something else? Take a look at all the loan types Money FCU has to offer.
What can you use a home improvement loan for?
Home improvement loans can be used for renovations or repairs, whether planned upgrades or unexpected fixes. Some popular home improvement projects for loan use are bathroom or kitchen remodeling, plumbing repairs, outdoor renovations, installing a pool, replacement roofing, room additions, and more. Speak to a friendly customer service representative at Money FCU to ask about financing your home improvement plans.
How could your home improvement project affect your homeowner’s insurance?
We would love to be able to say that all home improvements can lower your homeowner’s insurance rates, but this is not the case. A new roof will often lower your insurance rates. On the other hand, adding a pool will increase your rates. From an insurance perspective, some home improvements may render your plan inadequate to cover the new enhancements. Depending on what your project is, it may increase your liability as well as your rates. Speaking with your homeowner’s insurance agent ahead of time will help you prepare for the added costs.
Most importantly, you always want to make sure that your insurance coverage is adequate for your home. We always suggest speaking to your insurance agent about home improvements, additions, and renovations. Money FCU offers discount insurance rates through Liberty Mutual if you’re looking to save a little money.
A useful tool to help when you’re thinking about home improvements is a loan calculator. Simply enter your loan details, and the loan calculator will provide an estimate for your monthly payment. There are some free loan calculators online, including Money Federal Credit Union’s.
Knowing which loan is right for me.
There are many things to consider with all the different loan options. Think about not only your monthly payments but what options are going to work for your lifestyle.
Term length may be critical to someone concerned about having a loan that lasts more than a few years. Lengths can vary from one to twenty-five years based on the loan type you choose. Personal loans have shorter terms and higher interest rates. In comparison, a secured loan like home equity or HELOC has longer terms and lower rates. Every lender has different parameters for their investments, so always check their terms first.
Fees can add up
Understanding the extra costs of your loan is also an essential step in your decision-making. Personal loans don’t typically have additional fees since your home does not secure them. Home equity and HELOC loans will often include appraisal fees, application fees, closing costs, and attorney fees. Also, look for maintenance fees, membership fees, or transaction fees hidden within your contract. Interest rates, even low ones, over an extended period will add up. You should also be aware of any loan origination fee or payment penalty. Some lenders will penalize you for paying off a home equity loan early.
Money Federal Credit Union does not charge prepayment penalties on any of our loans. Getting charged for early payoff isn’t the only possible hidden fee. Credit cards that offer promotional rates or 0% interest usually charge hefty fees if you don’t pay off the balance within the promotional time frame. They may also charge you an enrollment fee to recoup some of the interest they’re losing on granting you 0% or that lower interest rate. Make sure you read everything to avoid losses.
Some risk comes with any loan. The most significant risk is in a home equity loan or HELOC because your home becomes collateral. If you don’t pay back the loan, the bank will take your house. Thus, if your income is unstable or you’re not comfortable using your home as collateral, you should go with an unsecured loan. In case you can’t make the payments, the Home Equity or HELOC is not the best choice.
Can I speak with a professional who will help me decide?
Customer service and loan specialists can give you all the details of each loan offered by that particular lender. Still, maybe you’re looking for something a bit more. Do you want someone to help advise what loan options would work for you and why?
Many financial institutions and credit unions have representatives who will look at your finances and help decide what your best options are. These trained professionals think for future planning and often have deep insight into investments and credit. They may make recommendations on which financing options and repayment plans would work best for your specific situation. Large home improvement loans are important decisions. So it’s good to consider having professional help. Some banks and credit unions even provide this service for free or for a minimal charge. Money FCU has financial coaches ready to help for free.
You can find more information and rates at www.moneyfcu.org.