Guide To Lenders
July 23, 2014

Home Improvement Loans: Which Loan is Right?

Gabriel Traverso

Homeowners planning home improvement may be wondering how to go about financing the project. With daily bombardment by radio and television advertising proclaiming the benefits of cash-out refinancing, home equity loans, or home equity lines of credit, it can be difficult to determine the best loan for your project.

 In general, home improvements become necessary at some point during the life of a house. Whether it's deferred maintenance or upgrades such as a new sunroom or an addition, owners must find a way to pay for the project. Some choose to use credit cards, others use a second mortgage, and some tap a line of credit.

The most appropriate source of cash depends on the owner's financial picture.

Cash-Out Refinancing vs. Home Equity Loans

Many homeowners don't have an in-depth understanding of the features and benefits of cash-out refinancing versus taking a second mortgage. Cash-out refinancing replaces an existing mortgage and loans additional funds for other uses such as home improvement projects. A home equity loan is a second mortgage, another loan with separate provisions, its own interest rate, and its own term.

 Refinancing Makes Sense When…

Cash-out refinancing is a good option for homeowners when: when the rate of the existing mortgage is higher than what could be obtained by refinancing; when a homeowner wants to fix an ARM that has reset or will be resetting soon; or when there is another reason he or she could obtain more favorable terms by refinancing the existing mortgage.

 A Home Equity Loan Makes Sense When…

A home equity loan is a better option than refinancing when the existing mortgage has a good rate and favorable terms and changing it doesn't justify the costs associated with a major refinance. Those who bought their homes a few years ago when rates were exceptionally low would most likely not want to replace their loans. Home equity loans can provide the funds needed for a home improvement project and leaves the first mortgage untouched. A fixed home equity second mortgage delives a lump sum to the borrower at closing, a fixed rate, and equal payments for the life of the loan.

 The Home Equity Loan vs. the Home Equity Line of Credit

A HELOC is another form of a second mortgage that homeowners can tap for funds. It differs from a fixed second mortgage in that it is a revolving line of credit. Like a credit card, borrowers are approved up to a limit and they can borrow as needed. The adjustable rate moves with financial markets, and the current rate and amount borrowed determine the payment each month. The line of credit can be paid and drawn upon as needed.

 Which is the Right Loan?

The borrowers' financial situation, lifestyle preferences and the scope of the home improvement project determine whether to refinance a first mortgage or take on a second mortgage. These factors also influence the decision between a second mortgage or HELOC. Homeowners undertaking an extended project that will require varying influxes of cash at different times may prefer the flexibility of the HELOC, and the fact that interest is only charged when funds are actually drawn can be advantageous. The fixed home equity loan offers the benefit of a fixed interest rate--no surprises, and is often best when a large amount will be used all at once.

 Many factors drive the decision in home improvement financing. Working with a financial advisor and a reputable lender can help borrowers evaluate their situations and aid in the decision making.


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