Financing your home remodel: expectations vs. reality

The average homeowner doesn’t have enough money sitting around to finance a home remodel, and if they do, they prefer to leave it in savings as a safety net for unforeseen financial emergencies down the road. Consequently, the average homeowner must borrow money in order to pay for home improvement. One option is to pay for everything on credit cards but the high interest rates make this an expensive option if you can’t pay them off quickly. A secured loan through the bank borrowed against the equity in the home is the most common solution. When these kinds of loans are borrowed with the purpose of home improvement, they’re called home improvement loans, and they’re a little different from other kinds of loans so here are a few things you might need to know.

Expectation: you’ll get your money in one lump sum

Reality: not necessarily. If you’re borrowing for the sole purpose of improving your home, banks will often disburse funds according to how most contractors take payment. A reputable contractor won’t take 100% payment up front. They’ll need a down payment as an act of good faith and to cover the initial orders for materials. After that, they usually are paid in installments which are tied to the successful completion of various stages of the project with a final amount withheld until the end.

Expectation: applying for a home improvement loan is like applying for a mortgage

Reality: not at all. When applying for a mortgage, you get an idea of how much you’re approved for, find a home in that price range, and obtain final approval. If you’re trying to get a home improvement loan, the bank is going to need more specifics. You’ll need to show them at least one or two estimates for the total cost of the remodel as well as a copy of the contract specifying how often and how much you’ll pay during various stages of the projects.

Expectation: you won’t get approved without enough equity

Reality: you can, but it’s more expensive. As long as you’re committing to spend the entire amount of the loan on home improvements, you can often get approved for a loan even without much equity. It will be an unsecured loan so the interest rate will be higher. The bank will need to see proof that the upgrades will increase the value of the property which they still technically own before signing off on it.

You may be better off paying for inexpensive projects you can do yourself like installing baseboard radiator covers or repainting while you build up enough equity for a 2nd mortgage or HELOC to finance a larger remodel.

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