Your Main Options For Financing A Remodel
Hello! I'm Jeremy, one of the owners of Phoenix Home Remodeling.
My college degree is in finance and I like helping people with money because there's a lot of stress it can cause us. I've also worked in the mortgage, wholesale lending, commercial lending, debt settlement, and credit score improvement fields.
That being said, everyone has different views on financing, saving, debt, etc. This article has the pros & cons of each option so you can see what best suits your needs.
Many of these options don't mean someone doesn't have the funds to pay for the remodel.
It's simply an alternative to hold onto your money and leverage financing. Some homeowners also do a combination of these options.
Important Distinctions of Financing
Compound VS Simple Interest
It's important to know the difference between these two. Albert Einstein said: "Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it. "
Compound interest is the addition of interest to the principal sum of a loan or deposit, or in other words, interest on top of interest. So if you have an investment that is making more interest on top of interest that is great. If you are being charge compound interest like a credit card then it is bad and it's the main reason it can be hard to get out of credit card debt.
Credit cards are the only form of compound interest you can be charged from the options mentioned on this page. So for that reason, credit cards can be risky, but that doesn't mean it should be taken out of consideration. More on that below under Credit Card Pros & Cons.
Simple interest is were you make or get charged a set amount of interest normally formulated at the start of the loan. A car loan and mortgage are both simple interest where the amount is predetermined at the start and you are not charged compound interest like a credit card.
Secured VS Unsecured Loan
A secured loan is where collateral is securing the loan payback so the bank would collect the collateral if the borrower does not pay back the loan.
Mortgages and car loans are the 2 most popular forms of secured loans.
Unsecured loans do not have any collateral attached to them so a little more risk is placed on the bank and they usually have a higher interest rate to compensate.
Most remodel loans and credit cards are unsecured.
This is where there is a penalty for paying the loan off early. Any loan you take out whether it is a mortgage, car loan or remodel loan, you want to always ask if there is a prepayment penalty. If there is one you want to know how long the penalty is for and how much.
If it was a 20yr loan with a 6mo prepayment penalty, that wouldn't be a big deal compared to a 30 yr loan with a 20 yr prepayment penalty. That is a slightly unrealistic example to emphasize the point that the timeline matters.
Pros & Cons On Remodel Financing Options
Below is a simplified way to analyze each main remodel financing option.
It is not all-encompassing analysis, but a high-level overview of the main options and the pros and cons.
Remodel 1st Mortgage Cash-out Refinance
Depending on many factors 5-7% interest rate + closing costs.
Pros of mortgages are simple interest instead of compound interest like credit cards.
They are secured by your home which reduces the banks risk and allows a lower interest rate. Rates are still currently low which is great.
Mortgage interest is also tax deductible.
Mortgages allow for a smaller monthly payment because they are spread out over a longer term.
Most mortgages don't have a prepayment penalty.
There is a mortgage program discussed below that offers a loan based on what your property will be worth AFTER the remodel is done! That allows you to borrow more unlike a HELOC mentioned below.
Cons are paperwork and processing can take time. (We know a company mentioned below who does a great job helping with those two items)
Closing costs can be a downside to a mortgage.
You pay for the loan over a longer period of time which is why you have a lower monthly payment.
HELOC 2nd Mortgage
Closing costs + higher interest rates than a conventional mortgage and the rate can fluctuate.
Pros of a home equity line of credit (HELOC) are it allows you to only pay on the amount you borrow. So if you only use 30k of the 50k available, you only pay on the 30k you borrowed.
You can pay off and borrow from the HELOC whenever you want as long as it isn't at the max loan amount.
Cons of a HELOC are the interest rate can fluctuate often and increase your monthly payment.
Normally the monthly payment they require is only for interest so you aren't paying the loan down. You have to pay extra and this tricks some homeowners.
Usually after 10 years it goes from a 30 year mortgage to a 20 year mortgage so any loan amount still on there gets a dramatic monthly payment increase.
Credit scores usually have to be excellent for a HELOC because of additional risk to banks.
You have to have a decent amount of equity in your home because HELOC are more risky being in the 2nd lien position compared to a regular mortgage.
Depends on the bank and qualifying criteria but the rate is usually 4%-$15%
Pros to a remodel loan are that they are for a short period of time so you often pay less interest compared to a mortgage.
It is unsecured so you are not tying it to your home.
You get fast approvals.
Remodel loans are simple interest so the amount of interest is predetermined in the beginning. It doesn't pile up the way a credit card does from compound interest.
Cons to a remodel loan are the higher monthly payment since you are paying it off in a shorter amount of time.
The interest rates are higher than a mortgaebut they are paid off much faster so less interest. (The remodel loan rates are less than most credit cards and it is simple interest which is better than being charged compound interest like a credit card)
Some of the best remodel loan terms require 720 or higher credit scores.
No initial fee normally but compound interest rates of 10-25% Some credit cards offer 0% for 12-18 months.
The pros to credit cards are not secured to a home or other property.
You can also earn points.
If 0% credit card that can give you 12-18 months to pay off without any interest. Some people will get a new 0% credit card a month before the other one is due and transfer the balance to give themselves another 12-18 months.
They are easy to apply for.
Cons to credit cards are remodel contractors get charged 3%-4% from their merchant account provider so you will get charged 3%-4% percent extra to cover the cost.
Credit cards are compound interest making it hard to pay off the balance.
Just like a loan, higher credit scores are needed for the best interest rates such as 0% card offers.
10% early withdrawal penalty and possible tax payments
Pros of a 401k loan are quick access to the funds.
Rates are usually pretty low, most are based on the prime rate +1%.
The interest you pay goes back into your 401k so it basically contributes to your plan.
Cons of a 401k loan are 10% early withdraw penalty which is quite hefty.
When you take money out that amount doesn't continue to earn interest.
You will most likely have to pay taxes twice - once on borrowing and once after retirement when drawing from the 401k.
Loan from family member
Hard to say but probably less than banks
Pros to a loan from a family member are lower interest rates, more flexibility and easier access.
Cons to a loan from a family member in my opinion are mostly around the closeness of the relationship and emotions that can be involved in different situations.
Cheapest option on paper
Pros of paying cash is no need for paperwork.
No additional interest being charged.
The cons of cash is using your money when it could be "working for you".
If you invest the money and earn a higher rate that si also compound interest (good when you are earning it) and you are paying on a loan with a lower interest rate that is simple interest, you are actually making money from the loan.
Of course this assumes you are ok with the risk of the investments making a higher return than the cost of the loan.
This is why some financing experts advise not paying your mortgage off even though it is a lot of interest over the life of the loan. Essentially making a higher amount of interest plus it is compounding interest will make more money than paying off the mortgage faster.
Who we recommend for remodel financing
As you can see there are a lot of options and it depends on your situation, risk level, and your long term VS short term goals.
There are few places we are willing to recommend. As I mentioned earlier, I came from the mortgage industry and there is only one company I would refer...
Bell Bank Mortgage
There's a ton of mortgage companies out there and the main reason we suggest Bell Bank Mortgage is because of their remodel mortgage program and their Sr. Loan Officer Joel Terrill. We did a remodel for Joel of his 3 bathrooms, entertainment wall with fireplace, and flooring. Joel and his wife are amazing people and he has been in the mortgage industry for over 25 years!
Bell mortgage has a program that allows you to borrow up to 95% of what your house will be worth AFTER the remodel is completed! So for a basic example, if your house is currently worth $450,000 and after the remodel it is worth $550,000 you can actually borrow on the future appraised value of $550,000.
Here are more details on Bell's mortgage program:
Here is more information to contact Joel Terrill:
Joel Terrill NMLS# 255385
We partnered with Hearth because they specialize in remodel financing and have several lenders and options.
They also have no prepayment penalties, offer lots of options, have competitive rates, and are a tech savvy company with fast approvals.
See the 2 banners below for a 0% option and a monthly payment regular option:
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