This is the 3rd post in my Articles by Request series. The first two posts were in response to the question “Can you explain how to save money while still raising a family and trying to keep up with what society seems to think a family needs to have?” and are titled Part 1 – The Joneses and Clothing and Part 2 – Living frugally, yet well.
The question was:
“Home Equity Loans. There’s two types, the one that refinances your entire house with the loan amount included in it, and the one where you take out a loan but you only draw against it as you need it, and you only have to make payments against the balance you have out. Which is better if you’re trying to remodel your home?”
This isn’t the easiest article to write, as my main focus is on getting out of debt and not incurring more. First, I must beat down my urge to scream “NO! Don’t Do It!!” Ok… that’s done.
Second, let me say that I am not an expert on finance or lending. There is a good article about Home Equity Lines of Credit on the Federal Reserve website, that includes information about HELOCs and 2nd Mortgages.
There are no hard and fast rules regarding financing the remodel of your home. If you don’t know how much it’s going to cost or it is an ongoing project, a Home Equity Line Of Credit seems to make better sense to me. You only borrow what you need, as you need it, and you have a specified amount of time to take out the money. HELOCs also have very few fees, and some lenders have NO fees associated with the HELOC.
If you take out a 2nd mortgage or refinance your home and take out some or all of the equity to finance the remodel, several things are at play. One, you have to pay many thousands of dollars in additional fees and closing costs. When we refinanced our house last year to get out of our ARM, we found out that mortgage companies are allowed to charge up to 5% of the total borrowed in fees and they make the numbers work so that the fees DO add up to that 5%.
Two, you have to anticipate the unexpected and take out enough equity in your home to cover everything that COULD go wrong. If construction costs are higher, or the remodel needs extra work to be brought up to code, or there is more wrong than you anticipated, you have to take out a significant amount more than your original estimate just to make sure you have it covered. Refinancing your house or taking out a 2nd mortgage only to find out that you have to borrow more money later through another avenue is an expensive prospect.
Three, you take out more than you need and end up with more debt than was necessary to complete the project. This isn’t the worst problem to have, except that when you borrow more than you need, it’s easier to piddle away that cash on things rather than just going ahead and paying it back toward the principal of the mortgage.
For more professional information, the National Association of Home Builders has an article on financing your remodel. I also found some good information on Smart — and Stupid — ways to finance your remodel at MSN Money.
However you decide to finance your home’s remodeling project, remember that what is right for you and your projects are not necessarily going to be right for everyone. Explore your own options.. and let me know what you find out!