17 September, 2021

Bereza Fire

Glorious home improvement

To pay with credit, cash, HELOC or other?

Tanisha A. Sykes

Donald Olhausen Jr., a 34-year-old real estate flipper in San Diego, did a major home remodeling project on his 2,200-square-foot Mediterranean-style home in 2018.

“We completely renovated the kitchen and bathrooms, replaced carpet, upgraded electrical and plumbing fixtures, and did carpentry work on the interior and exterior of the house,” says Olhausen. “We also added sod and new fencing to the front yard to help with curb appeal.”

The project was quite an undertaking, but more than worth it for Olhausen and his wife, Gabrielle, 25. To pay for the renovation, Olhausen, who was sole owner of the home at the time, borrowed $25,000 from his future father-in-law.

“It was risky because I had only known him less than a year, and he was going out on a limb for me,” he says. “It was definitely worth it because the house looks beautiful.” Olhausen has since repaid his father-in-law in full.

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The professional house flipper opted not to refinance his home mortgage or get a home equity line of credit (HELOC) because he wanted to save on interest and avoid paying a higher monthly mortgage payment. He also didn’t want the loan on his credit report.

“Even if you don’t use all of the money from a HELOC, you have access to it,” says Olhausen. “Therefore, credit bureaus will show you have borrowed that money, affecting your debt-to-income ratio.”

In its 2021 U.S. Houzz & Home Study, Houzz found that home renovation has grown 15% to a median of $15,000 over the past year, with kitchens, outdoor spaces, and home offices receiving the most attention.

Before you get caught up in the excitement of choosing fixtures and picking paint colors, take the time to figure out your financing options. Here are five of the most common ways to pay for home improvements.

Cash

Paying in cash means you can afford the purchases you’re making without having to fret over paying back high-interest debt. If you have a large sum of cash in a savings account gaining little interest, consider putting it to better use. “Because of inflation and the rising cost of goods, the purchasing power of a banked stockpile of cash continues to decrease over time,” says Samuel Eberts, a junior partner and financial advisor with Dugan Brown, a firm specializing in federal retirements, in Dublin, Ohio. He recommends saving at least six months’ of expenses for emergencies. “Beyond that, the money could be used for home renovations, rather than sitting idly in the bank,” says Eberts.

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Credit cards

Homeowner Olhausen also placed $5,000 of his renovation expenses on a credit card.

“That was my only option,” Olhausen says. “I would normally advise not to do so because interest rates will eat you alive.” Financing a home renovation project on a credit card is a bit of a double-edged sword, says Eberts. While many cards offer zero interest for a certain period of time, Eberts advises paying off the debt before that introductory period ends. Otherwise, you will be charged the regular annual percentage rate on the unpaid balance.

Home equity loans

A home equity loan, which is a type of loan that allows you to borrow against the equity in your home, may be a wise move given the low interest rates on the market. As of early August 2021, the average home equity loan rate was 5.35% APR, according to Bankrate.com.

“Mortgage rates are at record lows, so for a homeowner sitting on a pile of equity, a cash-out refinance is likely your lowest cost of borrowing,” says Greg McBride, chief financial analyst at Bankrate.com. “Many homeowners stand to benefit by refinancing anyway, and pulling cash out at that time could be the ticket to paying for large repairs or renovations.” 

You typically need to have 15% to 20% equity in your home to qualify for this type of loan, according to Bankrate.com. Keep in mind with a home equity loan, you’ll be taking on more debt and using your home as collateral. Adds Eberts: “Essentially, your home is on the line if you cannot afford the monthly payments.” Plus, you’ll have to pay closing costs and fees, therefore, make sure you understand all of the requirements of the loan.

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HELOCs

A HELOC is a line of credit secured by your home that gives you a revolving credit line to use for large remodeling projects. The HELOC offers a great deal of flexibility related to how you borrow and repay the money, says McBride. If a project needs to be completed in phases, you can borrow the money as needed, “and make minimum, interest-only payments when money is tight,” he says. 

But consumers should also be aware of the risks associated with this financial product.

Because HELOCS use your property as collateral, you could find yourself in danger of foreclosure if you fall behind on payments. In addition, these loans act as second mortgage payments; therefore, you’ll be making two mortgage payments each month. What’s more, the interest on these loans is variable.”

“A cash-out refinance offers the certainty of a fixed-interest rate and monthly payment,” says McBride. “But a HELOC carries a variable interest rate that would rise along with interest rates, and, after 10 years, convert to a repayment phase with higher monthly payments.”

HUD Title I loans

Title I loans are a good option for homeowners with a modest income level. On a single home, the maximum loan amount is $25,000 and varies for other types of homes, according to the Department of Housing and Urban Development requirements. “They are not intended to make luxurious or fancy upgrades such as installing a pool,” says Eberts. “HUD I Title loans are to be used to make a home more liveable.” 

For example, some homeowners apply for these loans to improve the accessibility of a home for people with disabilities, which may include adding a ramp or widening doorways, Eberts explains. 

These loans are issued by private lenders but backed by the government. Most lenders require the borrower to use their home as collateral for loans amounts above $7,500. For more info, visit Hud.gov

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