Do you need to add a garage, install windows
or remodel the kitchen?
Whether you decide to use an outside contractor
or go the do-it-yourself route, you're going to need some money
to get the job done -- and consumers should inspect their financing
options as closely as they would green lumber.
When looking to finance a home improvement,
"Consumers need to ask themselves a series of questions,"
says G. Richard Bright, senior vice president of the home equity
lending division at Countrywide Credit Industries Inc.
What to ask yourself
Lenders agree that those basic questions are:
- How long is it going to take to do the whole
- How much is it going to cost altogether?
Do I need the money for anything beyond this
particular set of home improvements?
Your answers will determine whether you should
choose from finance options such as a credit card, a home-improvement
loan, borrowing on your 401(k), borrowing from your portfolio,
a life insurance loan, a Title 1 Loan, a contractor loan, a
home equity loan or a home equity line of credit.
Pulling out plastic
"There is no one plan that is right for
everybody," Bright says. "If the job is just a couple
of hundred dollars, I'd use the credit card."
The credit card generally charges higher interest
than other options and the interest isn't tax deductible. However,
when you're borrowing a small amount, it's cost-effective and
relatively hassle-free because the other options can involve
a good deal of paperwork and upfront costs such as appraisal
and origination fees.
"If the job is going to be more than (a
few hundred dollars) or it's going to be in stages -- maybe
add a garage, do some pool repair and remodel the bathroom later
on -- then options lend themselves toward using the equity in
their home," Bright says.
The equity is just sitting there
Tapping into the equity of your home is a low-cost
credit vehicle well adapted to financing home improvements.
Normally, equity just sits there growing until you sell your
house. Home equity loans and home equity lines of credit, HELOCs,
let you use this asset without selling your home. In addition,
interest payments on a home equity loan are, within limits,
deductible on federal income tax.
The amount available in home equity lending
depends on the percentage of equity that your lender is willing
to fund. Some lenders, under some circumstances, may let you
borrow based on the increased amount of equity you'll have after
If you're doing the work yourself and you're
not a licensed contractor, an appraiser would be hesitant to
vouch for the quality of the work and you may have a harder
time landing this type of loan.
One-shot projects ripe for line of credit
If you're going to do a one-shot, straightforward
project such as putting in a pool, which will be paid upon completion
of the project, the home equity loan is probably the way to
The advantage is that you'll be able to budget
a fixed monthly payment until the loan is paid off.
But if you have an open-ended project, a HELOC
is the most flexible option. It is a definite advantage if your
home improvements bring unexpected expenses down the line. For
instance, there might be surprises hidden in a wall that a contractor
can't see when making an estimate. Or if you're doing the job
yourself, you might underestimate the materials needed or even
break that shower enclosure you're trying to install.
The HELOC advantage
The advantages of HELOCs are many, including
the tax deductibility mentioned above.
HELOCs are like credit cards and unlike home
equity loans in that they offer revolving credit -- you pay
on the amount you've withdrawn. Obviously, this is an advantage
in covering unexpected costs or for jobs where you pay out large
sums in stages.
"It's so flexible," says Kellon Tippett,
vice president at BB&T Corp.'s direct retail lending division.
"You can pay those costs as they come up without having
to go back and reapply, so it's relatively cheap for the borrower."
Borrowing on your 401(k)
If your employer's retirement plan allows for
borrowing for home improvements, then tapping your retirement
stash can be relatively painless. Because it's your money, there's
no credit check, less lag time and low rates.
But if you leave your job after having borrowed
from your 401(k), you will have to pay back the loan in full
or pay about 30 percent in withdrawal penalties and taxes. The
same IRS rules apply if you don't pay the loan back within five
"Whenever people do that, they put a hole
in their retirement planning," says Dee Lee, a certified
financial planner. Even though the interest you pay on the loan
goes into your retirement account, the balance after the loan
is paid will most likely be lower than it would have been had
you not borrowed.
Life insurance loan
Borrowing on the cash value you've built up
in your whole, universal or variable life insurance policy is
easy because there's no credit check.
"You can borrow up to 96 percent of [the
policy's cash] value. The neat thing about an insurance loan
is all you have to do each year is pay the interest," says
George Zepeda, a certified financial planner and owner of the
Ann Arbor Center for Financial Services in Michigan.
When insurance companies pay interest on these
policies, they continue to credit the interest even though you
have the loan out. For instance, if you take out a $1,000 loan
at 7.5 percent and the insurance company is paying 4.5 percent
on the policy, then the net cost is 3 percent. But you earn
a lower interest rate on the borrowed amount until the loan
is paid back.
If you're borrowing against the cash value,
you may be lessening the death benefits. This means if you die
before you pay the loan off, your family will receive a smaller
Borrowing from your portfolio
You can also tap your securities by taking a
margin loan. There's no credit check, and you don't have to
pay back the loan if the market does well. You can borrow from
75 percent to 95 percent of the value of the securities, says
Gerri Detweiler, author of "Slash Your Debt". But
she recommends that you borrow no more than 50 percent.
"People have to understand when borrowing
on your portfolio, you're using your securities as collateral,"
warns Scott Kahan, a certified financial planner. When the market
drops, the value of your collateral drops. If it is no longer
valuable enough to secure the loan, you may be forced to sell
Title 1 loans
If you have limited equity in your home, you
may qualify for a federal loan. Banks and other lenders loan
from their own funds and the Federal Housing Administration
insures it. The interest rates are negotiable with the lender,
and the loans can't be used to pay for luxury, nonessential
improvements such as swimming pools or work already done. But
they can be used if a person with disabilities wanted to make
improvements to make their home wheelchair accessible.
Taking money from contractor
Avoid making financing arrangements with your
contractor, especially if he seeks out your business.
"Arrange the loan first then deal with
the contractor," says James Hood, editor-in-chief of Consumeraffairs.com.
"Contractors most of the time don't fully disclose finance
Contractors may get commissions from sub-prime
lenders, and the deal you sign can be loaded with hidden fees.
Don't give the contractor a large lump sum of
money prior to starting the job. Because if it isn't done to
your satisfaction and you've paid the contractor 80 percent
to 90 percent of it upfront, then you're out of luck.
"Many people give the contractor
way too much money upfront," he says. "You have to
hound them to the ends of the earth to get the last 10 percent
of the work done."