Springtime and summer are the most popular times to embark on home remodeling projects. With interest rates low and real estate values creeping higher to strengthen home equity, many homeowners will finance those improvements with a bank loan.
But before shopping for a loan, it helps to understand which particular financing will best suit your needs.
Banks often call all sorts of different loans “home improvement loans” just because you can borrow money lots of different ways and spend it on home improvements.
• But strictly speaking, a home improvement loan is a particular loan that the bank will offer you that must only be used for approved home improvement projects. The bank will base the amount of the loan on the value of upgrades you plan to do, after reviewing contractor bids.
• If they approve the loan, the bank will also do regularly scheduled inspections of the work in progress. When the work is done correctly, they’ll release funds to pay the contractors.
• So the bank will help you oversee the construction work and keep the contractors on a productive schedule. Once the job is completed you will begin paying off the loan, based on whatever agreement you reached with the bank.
Or if you have equity in your home, you can borrow against that using a home equity loan or line of credit. But be advised that both of these kinds of loans use your home as the collateral to secure the loan, so if you default you can lose your home to foreclosure.
• If you decide to go that route, the home equity loan will be paid in a lump sum up front, and you’ll be charged a fixed rate of interest. You usually have up to 20 years or more to repay the loan.
• A home equity line of credit (HELOC), on the other hand, charges a variable rate, which could potentially rise over time. But you decide if and when to borrow, kind of like you do when using your credit cards.
• With a HELOC you only pay interest on the amount you borrow, and can repay the line of credit over a period of usually 10 or 15 years.
So weigh the pros and cons of each of these approaches if you plan to use home equity financing. You can borrow against a credit card, of course, as long as the project is not a very expensive one. The problem with putting the cost of a project on plastic, of course, is that credit cards typically charge extremely high rates of interest.
• Consider this, for example. If you borrow using a zero-percent interest credit card promotional offer, you may get a great deal that amounts to a free loan.
• But once the promotional period expires – usually within six months or so – the remaining balance will be charged a hefty fee of maybe 15 percent or higher. What’s even worse is that if you make just one late payment, your cheap promotional rate will be replaced with a super high penalty rate.
• That rate – which can be as high as 25 to 30 percent – continues until you pay off the whole balance. A debt repaid with 25 percent interest will double in just four years.
So if you have a home improvement project in mind, talk to your banker about an affordable home improvement loan. If that doesn’t appeal to you, consider a home equity loan. But make sure you can repay it. Otherwise that new kitchen or room addition won’t do you much good because you’ll be foreclosed on and the house will no longer belong to you.