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Financing a remodeling job
By Salvatore Caputo and Leah Gliniewicz •

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 job?
  • 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 the improvements.

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 go.

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 years.

"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 payout.

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 the stock.

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 "Contractors most of the time don't fully disclose finance charges."

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."



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