Tips for financing a kitchen or bath makeover

piggy bankIt’s no secret that crafting the kitchen or bathroom of your dreams will cost a pretty penny. The good news is that if it’s done properly, your investment will last as long as you own your home, and increase your property value to boot.

But what are your options when you’re ready to take the plunge and don’t have tens of thousands of dollars sitting idly in your checking account?

Financing your renovation is a perfectly intelligent move if you cross your t’s and dot your i’s. Here are a few pointers to help the loan process go as smoothly as possible.

Budget first, design later

Prior to even thinking about financing, determine a realistic number for how much you can afford to spend. Once you’ve got this number, work backwards to allocate that money in the most efficient fashion.

It’s a mistake to start designing your ideal kitchen or bath before calculating the cost of recreating your vision. Start with your budget and then fill in the pieces from there.

There are two reasons this is a smart move:

  1. By setting your maximum budget up front at an appropriate level for your income you greatly increase the likelihood of having your loan approved.
  2. Sticking to a strict budget helps you get more creative. Perhaps those old cabinets would be okay with a facelift if it means $4,000 is freed up to spend on truly luxurious faucets and accessories.

When you’ve determined your budget and you’re ready to start, here are some of the financing options available:

Cashing out equity

The most common method for financing a renovation when “saving up cash” simply isn’t an option is to tap into the equity of your home. Most banks will loan up to 85% of your equity via a line of credit.

The advantage of a Home Equity Line of Credit is that the bank couldn’t care less what you do with the money. If the equity is there and you choose to take it, the bank will approve your loan as long as you can prove solvency to make the monthly payment.

A line of credit is great because you can pay down the loan whenever you’d like and take more out if need be. You only have to pull the amount you require and so interest is calculated solely on this total.

The disadvantage of a line of credit versus cash-out refinancing is that interest rates on home equity loans are higher versus a traditional mortgage.

Cash-out refinancing is an alternative method for pulling out equity where you refinance your entire mortgage while rolling in additional monies to the loan. Say you owe $150,000 on a $300,000 home. You can refinance at $200,000 and receive a check at signing for the difference. In this case you must define an exact amount to borrow and will pay interest on this full amount for the life of your loan.

It’s important to remember that refinancing resets your mortgage from scratch and that there are additional costs associated with closing the loan. In many cases a lower interest rate is not sufficient to cover these additional costs and so a cash-out refinance can cost more in the long run versus a home equity loan.

Spending the equity you’ve earned on improving your home is a smart idea but be sure to discuss the two “equity out” options in full detail with your lender to ensure you take the shrewdest course of action.

Retirement fund loans

Many 401K or IRA plans have provisions that allow participants to borrow against their own portfolios in certain scenarios. Check with your retirement plan administrator to see if home renovation loans are permitted under your plan.

The beauty of these types of loans is that the interest is often paid back into your own account. In essence you pull assets out of your fund to reinvest by loaning them to yourself. Talk with HR or your account executive for details on your situation.

Personal line of credit

Those without sufficient equity in their home to reach the 85% rule can still look into a traditional line of credit.

Loan approval will be based off your income and interest rates will be higher since this type of lending is not generally backed with collateral.

Renovation refinance

In cases where remodeling plans will drastically increase the value of your home it’s possible for the bank to refinance your mortgage at a level higher than the property’s current value.

Renovation refinancing is more difficult to get as the bank is essentially basing loan terms off your home’s “future” value.

Be honest about repayment goals

There is no “one fits all” solution that works for every family.

If you plan on buckling down and paying off the total loan within the next 12 months it could be that throwing the whole shebang onto a credit card will actually cost less than covering closing costs on a home equity loan.

If you are happy to pay an extra $100 on your mortgage ad infinitum for the life of your loan and have no interest in early payoff then cash-out refinancing will fit the bill.

Be realistic about how much you can afford to spend and how quickly you can (or are willing to) pay off the loan. These two factors play the most prominent roles in determining your ideal financing resolution.

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