The three best loan choices for remodeling home
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By Scott Sheldon  November 8, 2013 12:00 am

Home equity has reappeared for many Sonoma County homeowners, making home improvement projects a reality. Redoing the kitchen? Adding on a bathroom? How about replacing the roof? All of these can be a pricey investment. 

Here are the top three loan solutions:

Home equity line of Credit, a.k.a. HELOC

The program creates a line on the property similar to a gigantic credit card but is secured by your home unlike a credit card, which is unsecured. 

You as homeowner have the ability to borrow on a certain percentage of the line amount and have to pay that back based on an interest-only monthly payment within the first 10 years. 

So, from an accounting perspective, the program is attractive because the mortgage payment is quite low. 

The pros include:

• Cheap as long as interest rates remain favorable;

• Takes 30 days or less;

• Goes up to 80 percent loan-to-value or combined loan-to-value with first mortgage; 

• Payment is interest-only based, so if you make a larger payment towards principal, that will be reflected in the following month’s payment i.e. it will be lower.

The cons include:

• An adjustable rate mortgage that moves in sync with the prime and Fed;

• Payment is interest-only, and principal balance only reduces when over payment is made;

• If the first mortgage is going to be refinanced, the second lien holder holding the equity line will have to agree to subordinate to a new first mortgage, essentially have to agree to remain in second position on the property.

 

Cashing out 

refinance mortgage

This option essentially involves cashing out a first mortgage to payoff the current mortgage and any subsequent second mortgages in addition to borrowing enough funds to cover the cost of the remodeling. To complete a cash-out refinance, most lenders require a loan to value of 75 percent and a high credit score in the neighborhood of 700 or better.

  The pros include:

•  It’s a longer term solution as the payment is fixed rate compared to a HELOC;

• Takes 30 days or less to obtain;

• Goes up to 75 percent loan-to-value of the home;

• Timely repayment of principal and interest results in monthly principal balance reduction.

  The cons include:

• Interest rate could be higher than current first mortgage rate;

• May need to finance more than the cost of the project, thus paying interest on money not needed;

• May not be able to get as much cash out because of 75 percent maximum loan to value;

 

Personal loan/bank or online

This choice can be obtained from a local bank or even from an online lender. Rates are anywhere from 11-12 percent with excellent credit to low 6-7 percent rates working with a peer-to-peer online lender. 

These loans typically have shorter terms and are unsecured, thus higher rates offered. The shorter the term the higher the payment making a personal loan pricier.

 The pros include:

• No loan-to-value is required, so if there is an equity obstacle, it can be paid off sooner than traditional financing;

• Faster access to securing funds.

The cons include:

• No tax advantages;

• Substantially higher rates compared to refinancing a first mortgage or obtaining a home equity line of credit;

• Higher payments on these loan types must be counted into debt to income ratios on future financial transactions limiting ability to qualify.

Because home improvement project costs especially larger scale endeavors such as, an addition of a bedroom or remodeling of the bathroom for example tend to vary, it’s always ideal to try to get more funds than necessary to account for variances. With all of the three financing types laid out, if the additional funds are not needed, they can be reinvested back into the principle balance of the debt. 

However, of the three choices, the only one that would favorably affect the payment would be the home equity line of credit. 

The other two options are based on principal and interest amortizing loans wherein the payment would remain constant despite the principle balance reduction.

 

Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.

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