Financing a renovation is a challenge for many people. But depending on debt ratios and equity in the house, the opportunities are actually very plentiful. Depending on when, how and why you’re buying the property, a customized plan should be made for you with your lender and financial planner. Three common options for renovation financing are securing an equity line of credit, getting a construction loan, or borrowing from a 401(k).
The most popular option is to use equity in the house to finance the line of credit, known as an equity line of credit. This is a tried-and-true method used by owners with significant equity in the house. Most loans are going to give you 75-90% of your equity in your house as a line of credit.
Example:
- $300,000 house with 20% put down when at purchase
- Access to approx. $45,000 equity line of credit
This money is available for you to use for renovations and improvements—and you don’t pay interest on money in the credit line, only the used balance of the account.
A construction loan is the second best tool for financing a renovation. This option is best for larger scale projects, or projects for which you have a large equity position or cash-on-hand deposit you’d like to leverage for the major addition to the house. These loans are typically a 12-month interest only term for a specified amount of money, and you pay interest on the entire balance of the account the moment that the loan is approved.
The last option is a 401(k) loan. The 401k loan is a not a product, but it’s a divesting of money in your current investment portfolio. The maximum is 50% of your balance, not to exceed $50,000. The money is not taxed as income, but you may have to pay sale penalties from your investment broker. The loan must be re-paid within 5 years and can be repaid on an amortization schedule. The difficulty of this loan is that you are missing the advances in the marketplace when its withdrawn, but the benefit is that you miss the decline of the market during your withdraw. Consult your financial planner on this loan as your “cost of money” is unknown.
Once you’ve decided on the best financing option for your renovation project, you’re ready to call your architect or general contractor and start the conversation about planning the renovation.
And don’t forget to have your realtor—or better yet me—review your plans and your budget to make sure you’re adding value in the correct place in your home and maintaining relevance in the housing community!
