Every month, we encounter common questions from our clients about how to finance their home remodeling projects. Prior to the start of our remodeling company in 1999, I spent 6 years in banking. In the early years of my banking days, I facilitated different types of consumer loans directly to homeowners and later in my banking career, my focus shifted to working on the actual lending platforms that served clients.
In this newsletter, we aim to share valuable advice and guidance for homeowners embarking on the journey of financing their dream home renovations.
Whether you’ve lived in your home for decades and are eager to start your project immediately or if you’re a new homeowner planning for a remodel in the near future, there are financing options available to suit your specific needs and circumstances. The key is to identify the best approach to financing your specific project.
There’s a saying that “Cash Is King” and we will assume for this discussion that your use of cash will not cover the entire cost of your project and some form of financing is going to be needed.
Understanding Your Project's Duration
The truth is where you are in life plays a key role in what elements you may include in a project. It certainly plays a role in how much you invest. So, in many cases not only are you trying to figure out how you plan to pay for the project, but you are also considering which elements are worth including in the project. For example, luxury product finishes might not rise to the top of the priority list when you just want to finish the basement and get the kids toys out of the living room. A functional space with durable products could win the day in that scenario. Conversely, if you’ve been in your home for 20 years and are finally getting the kitchen of your dreams, those quartz countertops might be non-negotiable. After all, you’ve waited all these years to get exactly what you want!
Once you’ve decided what’s in and out, a key factor to consider when exploring financing options for your remodeling project is the duration you plan to stay in your home. The length of your stay can influence the choice of financial tools that best align with your goals.
Credit Cards: A Short-Term Solution
For projects with a short timeline, such as an immediate need for emergency repairs or quick fixes, some homeowners may be enticed to use a credit card to pay for the repairs. While credit cards can provide an immediate source of payment, it’s crucial to avoid carrying the cost of paying for projects over an extended period via credit cards due to their high-interest rates. Would we ever suggest not getting your heat fixed in the winter if your only source of payment was a credit card? Of course not. You do what you must in certain situations, but in such cases where you are dependent on emergency repairs, it’s advisable to inquire directly with the service providers, like heating and cooling companies or plumbing companies, about their lender-direct financing programs, which often offer lower rates for short-term loans compared to credit cards.
Company Financing Options
Certain remodeling and home improvement companies offer financing options for their clients. Prior to Covid, we had a fantastic personal loan tool that I readily recommended to clients for a variety of reasons. The loans were unsecured. The rates were reasonable for borrowers with solid credit. The turnaround time for approvals was very quick. The process was easy and most importantly, the fees were minimal. That’s a very difficult product to find in today’s environment.
While the idea of having the company provide a financing option can be convenient, it’s essential to scrutinize the associated fees and interest rates. It’s crucial to ensure that these financing packages are transparent and not burdened with excessive costs. Translation: Be weary and do your homework. Don’t get taken advantage of simply because it is an easy option. In my opinion, creating and maintaining lifelong relationships with clients is paramount and there is no way I will suggest a financing option that isn’t in the best interest of the client simply to get a deal done.
Home Equity Loans: Tapping into Your Home's Value
In my experience, the most common paths to financing remodeling projects involve leveraging your home’s equity. Home equity loans typically come in two forms. The first option is a traditional home equity loan approved by the bank for a fixed amount. The second option is a line of credit, often referred to as a HELOC (Home Equity Line of Credit). The choice between these options depends on your preference for the ongoing use of funds over time. Let’s review how each product works as a starting point.
- Traditional Home Equity Loan: Ideal for projects with a fixed cost, as you receive the entire loan amount upfront, but full monthly payments including interest payments begin immediately. If you know the defined cost of your project investment and you know that you will want to pay this balance down without need for tapping into the equity of your home again in the future, then this could be your chosen financing tool.
- HELOC: This option operates like a checkbook, allowing you to borrow against your home’s equity as needed. Interest is only incurred on the borrowed amount, providing flexibility for varying project expenses. For example, let’s say you have a line of credit and make payments to your remodeling partner throughout the project. You only pay interest on the amount of the line of credit in use and as you pay the balance down over time, those funds become available again for you to use… maybe for the next project?
- It’s important to note that in many cases, a HELOC is the initial tool selected for financing, then later when the time frame for the use of the line of credit expires, you either get reapproved for another line of credit or your balance converts to a traditional home equity loan to be paid off over a defined period of time.
Tax Benefits of Home Equity
One potential advantage of using home equity to finance your project is the possibility of tax deductibility. Consult with your accountant and financial advisors to explore potential tax benefits associated with home equity financing.
Future Value Loans for Larger Projects
For larger remodeling projects where homeowners want to make substantial investments, there is a financing tool available that I affectionately refer to as a “future value loan.” That’s not a technical term, but it operates as the name implies. This financing approach allows you to borrow based on your home’s anticipated post-renovation value, provided you have comparable properties in your area to support the appraisal. In layman’s terms, the today value of your home may not offer enough equity for you to pay for the project you want to complete, but if a lender was willing to look at what your home would be worth after the remodel is complete, the deal could make sense to the bank provided there are enough homes in your neighborhood that are comparable to your home’s future value. These future value loans often involve an initial construction loan during the project that transitions into a permanent mortgage after the project’s completion.
One example of the use of this type of lending tool would be a home that is on the smaller side in its general neighborhood and the homeowner wants to add square footage to the home, thus bringing it in line with the size of other homes in the area. In another example, we once did a project in a home in an older neighborhood where we remodeled a kitchen and several bathrooms. The bank looked at the projected value of this home after the proposed renovations and determined that the future value of the home provided enough equity to finance the project with a client.
The key to being able to use this type of financing tool is that you must have higher value homes around you to serve as “comps” so when the bank goes to compare the future value of your home after renovations, there are credible comparisons to justify the bank’s risk.
203K Loans: A Government Option
An FHA-funded 203K loan can be an option, particularly for first-time buyers looking to renovate their homes. This government program allows borrowers to combine their mortgage and renovation costs, provided they find a lender and a remodeler experienced with 203K loans.
Not every contractor participates in this type of loan program due to the complexity of interacting with the paperwork and funding elements of this program, so please understand you may have to work a little harder to find a partner for this type of project.
Financing your home remodeling project requires careful consideration of your project’s scope, timeline, and your long-term financial goals. As the cost of remodeling projects continues to rise, taking advantage of financing options that align with your situation is critical. Remember that your priorities and financial situation may change over time, so choose a financing method that suits your needs and consult with experts to make informed decisions.
If you have more questions or need further information, don’t hesitate to reach out and ask. We look forward to assisting you with your remodeling endeavors. Thank you for reading and have a wonderful week!
Home Maintenance Tip:
Furnace Inspection for a Warm Winter
One essential home maintenance task to consider this season is a furnace inspection. Ensuring that your heating system, whether it’s a furnace or a heat pump, is in top-notch condition is the key to a cozy and energy-efficient home during the winter months.
What You Can Do
- Schedule a Professional Inspection: Contact a qualified HVAC technician to inspect your heating system. A professional inspection is essential for a thorough assessment of your furnace or heat pump.
- Check for Safety: The technician will inspect the system for safety concerns, such as gas leaks, carbon monoxide emissions, and any potential fire hazards.
- Clean and Lubricate: Dust and dirt can accumulate in your heating system’s components. The technician will clean and lubricate moving parts to ensure proper functionality.
- Replace Air Filters: A clogged or dirty air filter can hinder airflow and reduce efficiency. The technician will replace or clean the filter, ensuring improved indoor air quality and system efficiency.
- Inspect Venting and Flue: Proper venting is crucial to prevent carbon monoxide buildup. The technician will inspect the venting and flue to ensure they’re clear and functioning correctly.