Summer is peak remodeling season for homeowners and contractors around the U.S. But unlike recent years, 2017 could present more challenges for those looking for the best deal (and who isn't?). To make the decision on what to fix and how to pay for it, be sure to carefully weigh all the options and pick the most appropriate method to finance these projects.
Current remodeling trends
According to research from the Joint Center for Housing Studies at Harvard University, U.S. homeowners took advantage of favorable financing in droves for most of 2016. By the end of the year, households had spent almost $300 billion on renovation projects, with overall activity in the market up 7 percent compared to the same time in 2015. The JCHS explained that much of this uptick was attributable to a confluence of rising property values and falling interest rates on consumer loans. The end result was more owners either leveraging their existing mortgage debt to pay for home improvements, or simply dipping into savings in a time of renewed economic optimism.
"More homeowners are tapping into equity to finance renovations."
But like anything else in economics, what comes up must inevitably fall down. While total dollars spent on renovations will continue to rise past $318 billion by 2018, according to JCHS projections, remodeling activity is expected to fall as interest rates rise.
"Homeowners are continuing to spend more on improvements as house prices strengthen in most parts of the country," said Chris Herbert, Managing Director of the Joint Center for Housing Studies. "Yet, recent slowdowns in home sales activity and remodeling permitting suggests improvement spending gains will lose some steam over the course of the year."
This doesn't mean homeowners should put off much-needed repairs, or even delay improvements that are more aesthetic than functional. Simply consider all the options available for financing these projects and choose the one that's most sensible given the unique situation.
Paying with cash
Cash is always an option, and might even be the most advantageous in certain scenarios. As pointed out by personal finance columnist Ann Carrns, cash is king when it comes to simplicity and return on investment. Since the interest paid on a typical savings account is rarely more than 1 percent, and often much less, it makes sense to funnel that money into home repairs that could pay for themselves over time. Consider cash if time is of the essence - for example, if repairs are needed quickly due to an emergency situation or an impending home sale. Of course, the main drawback to cash financing is that homeowners need to have enough of it.
A home equity line of credit is among the most popular options for financing a remodel because of their flexibility. Like a home equity loan, a HELOC can convert some of the equity built up in a mortgage to cash, and it functions like a revolving line of credit similar to a credit card. HELOCs are usually structured in two phases: First is the draw period, when homeowners borrow against their home equity and pay only interest, usually for about 10 years. Afterward, the HELOC changes into what is essentially an installment loan, in which both interest and principal are repaid.
Interest rates on HELOCs average around 5.4 percent, but may offer introductory rates below 3 percent. Borrowers typically have about $50,000 to use over the draw period. A HELOC is a great option for financing renovations, especially in markets where home values are continuing to rise. However, homeowners could risk foreclosure if they default on a HELOC.
Home equity loan
As a more straightforward version of a HELOC, a home equity loan might be preferred for its simplicity. These loans are also based on built-up equity, but take the form of a lump sum payment rather than a revolving credit line. That allows borrowers to begin repairs while paying them off over time, with the same risk of foreclosure as in a HELOC. However, according to Carrns, conventional equity loans are becoming less common, since they are generally riskier for creditors than a HELOC.
What else to know
Before signing onto any loan, borrowers need to be familiar with all the details. Some common questions revolve around the following topics:
- Time limits on a HELOC: Lenders often require borrowers to take on a minimum amount of debt during a draw period or risk bigger interest payments. This can cause problems if repairs can't be completed or paid for in time. Before agreeing to a HELOC, borrowers need to be certain the minimum draw is within a reasonable timeframe that would allow them to schedule work.
- Disadvantages of fixed-rate equity loans: These products differ from a HELOC in that they are a lump sum installment loan, rather than a revolving credit line. If your renovation project happens to go over budget, it would be impractical to take out an additional loan.
- To balance time and financial constraints, use a standard home equity loan for projects that can be completed quickly. Stick with a HELOC for long-term projects that need to be done in stages.
Don't forget to save every document regarding your equity loan and the renovations you finance with them, as they may have tax implications. You can usually deduct loan interest from income taxes similarly to mortgage interest. Speak with a financial professional or your lender to be certain.
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