Home ImprovementWhose Money to Use
There are many ways to obtain financing for your home improvement project. Here are just a few
(in order of popularity):
Home Equity Loans
These are the most popular loans for home remodeling. They are tied to the equity in your home
and may be tax deductible. Most are available at competitive interest rates.
There are two types of home equity loans: line of credit and lump sum. In a line of credit loan, you
and your lender set a maximum amount of money that you can draw upon during the course of your
project. This allows you the flexibility of withdrawals. You can make your withdrawals as needed, and you
are only obligated to repay the amount of money you withdraw, plus interest. However, be aware that
the interest rates on line of credit loans are frequently pegged to the prime rate and can change any
time prime changes, or even more frequently.
A lump sum or installment loan is a one-time lump sum withdrawal of a set amount, which you repay
in monthly increments usually with a fixed interest rate. The sum is based on the equity you have in
your home. Equity is the value of your home minus the outstanding balance on any mortgages. The amount
of equity required depends on the particular lender program.
WARNING: If you cannot repay a home equity loan, you could end up losing your house.
When you refinance your home, you are in effect obtaining a larger mortgage to pay off your
existing mortgage. The excess funds can be used to finance your home improvements. The big drawback is
that refinancing often costs between 3-5 percent of the loan amount and can take as long as getting
approval for a first mortgage. This type of financing only makes sense if you were already planning to
refinance your home or if you can obtain a much lower interest rate than you are currently paying.
No Equity Loans
Some lending institutions offers loans to homeowners who do not have sufficient equity in
their homes to get a home equity loan. No equity loans offer a range of benefits and loan amounts and
can work as a consolidation loan to lower your overall debt. The big benefit is that these loans usually
are tax deductible.
The Federal Housing Administration (FHA) began Title I financing
for property improvements under the National Housing Act of 1934. This program
is still available. Loan amounts range from $1-25,000, with no equity required.
FHA loans do require additional paperwork and can take more time to secure.
Loans against securities you own are the next cheapest source
of funds after home equity and no equity loans. With a margin loan, some brokers
will let you borrow up to 50 percent of the value of your stocks and up to
90 percent on U.S. Treasury securities. The interest rates are also competitive.
In addition, you may deduct the interest against investment income (but not
against ordinary earned income).
WARNING: There is a risk attached to
these loans-if your stocks go down in value, you will be called upon to deposit
more money into your account (known as a margin call). If you cannot come
up with the money, you will be forced to sell your stocks when the market
There are many types of personal loans available: debt consolidation;
unsecured lines of credit based on your earning capacity or net worth; and
lines of credit secured by a possession, such as a car or a savings account.
The interest rates for personal loans depend on the borrower's credit and
what is used for collateral. For example, loans using savings accounts as
collateral may be priced as low as 2 percent above the savings/CD rate.
WARNING: Remember that accounts used
as collateral will not be available for other purposes.
Loans from Retirement Plans
You may be able to borrow against a defined-contribution
retirement plan, such as a 401(k) or company profit-sharing plan, depending
on where you work. The availability and terms of these types of loans will
vary from employer to employer. Usually, if a company allows these loans,
you can borrow up to half of your vested balance or $50,000, whichever is
less. You will be required to repay the loan in full within five years or
if you terminate your employment. The interest on these loans is not tax deductible.
WARNING: There are significant IRS restrictions
on these types of loans. If you do not follow the rules and restrictions,
you may be faced with a 10 percent penalty fee, plus income taxes on the money
If you have a whole-life or other cash value insurance policy,
you can borrow against that policy. The death benefit will be reduced by the
amount of the loan. If you die before the loan is repaid, your heirs will
receive the face value of the policy less the outstanding loan balance.
Credit Card Loans
These are as quick and easy as visiting your local bank.
Your credit card will determine the amount of money you can borrow and what
interest rate you will be charged.
WARNING: As easy as this is, it is one
of the most expensive ways to borrow and should only be used if you need money
quickly and plan on repaying the loan just as quickly. The interest rate charged
is usually quite high.
Reprinted with permission of (NARI) the National Association
of the Remodeling Industry.