How to Pay for Your Remodel
I see you. You’ve been daydreaming about your new space for years. You’ve wanted a new kitchen since you bought the place; your kids have been fighting over the shared bathroom since you moved in; and every time your friends come over you thank the universe that you have sweet, understanding friends that don’t mind cramming into your tiny living room. Maybe the master closet has been getting smaller and smaller, or the kids are finally old enough to need separate bedrooms. Whatever it is, you’ve lived with your space for a long time, and it’s finally getting to a breaking point, but there’s one big, giant, scary uncertainty holding you back.
How much would it cost, and how would I even pay for it?
It’s the number one question I get asked, and I’m here to tell you that it doesn’t have to be scary, and it doesn’t have to hold you back anymore! I’m here to give you a really quick rundown on the most common ways to pay for a remodel, and the best way to get confident on that number and put a plan in place to make your dream finally happen.
Ready? Let’s go!
The 5 Most Common Methods
Most people fund a remodel in one of five ways:
- Cash (inheritance, gift funds, or savings)
- Cash-out refinance
- Home equity loan or line of credit (HELOC)
- 203k, HomeStyle, or another type of renovation loan
- 401K or other retirement savings account
Cash and cash-out refinances are the best options if they’re available to you. They involve the easiest process to gain access to the money, have the fewest hoops for you and your team to jump through, and you have the most flexibility as to what you do with the money.
The HELOC is probably the most common option for financing a remodel, but do your homework and go into it with your eyes open – it has some major drawbacks. Because of the way HELOCs are structured, you only pay interest over the initial “draw phase” of the loan, so you won’t make a dent in the principal despite all those payments; then when the “repayment phase” kicks in you suddenly start paying principal plus interest. The monthly payment can increase dramatically and catch you by surprise, especially if life has thrown you any curveballs or you stopped paying attention and haven’t planned for the increased payment. A Home Equity Loan is like a typical loan with a lump sum withdrawal and amortized payment schedule, which can save the shock of a payment increase down the road. Both of these financing methods run the risk of foreclosure if you can’t pay them back, since your home is used as collateral. The main benefits of these types of financing is that you’re still free to use the money however you like.
The FHA 203(k) loan and Fannie Mae’s HomeStyle Renovation loans have their own unique set of challenges. They require a down payment of 3 1/2 to 5%, and you have to qualify for them the same way you would for a standard mortgage loan. The contractor has to work closely with the lender, providing detailed cost estimates and labor and material breakdowns early in the process. Those estimates have to be approved by the lender, so you’ll have to find a contractor who can be (and doesn’t mind getting) approved to do the work, and who is willing to jump through the hoops to help you with your lending. The lender is in charge of holding and dispersing the funds, so you won’t have the freedom of deciding how you spend the money. You’ll also need to know what you want to do and how much it’s going to cost before you can even get started with a renovation loan, which of course is a tricky chicken-or-egg situation for most people. Renovation loans are the most complicated and stressful of the financing options, but if you don’t have equity in your home it may be the best way to obtain remodel funds for your project. Just make sure you have an experienced team that are all 100% devoted to helping you succeed.
Lastly, any draw on your retirement savings is risky business, especially the closer you are to retirement and needing those funds available. Carefully weigh your options here and make sure you’re still on track to meeting your larger life goals if you do pull from these important savings. You’ll also want to talk to your financial planner about the tax implications and what the overall effect is on your financial picture.
If you're planning to finance:
If you’re planning a HELOC or renovation loan, there are a few ways you can make sure you are fully prepared have the best possible experience.
Find the best lender. Start with your current bank; what options do they have for loan products? How are the rates compared to other lending institutions around town? Sometimes having an existing relationship can work in your favor, especially if you have several financial products like loans or lines of credit and your account is in good standing. Don’t be afraid to branch out though and compare what you learned at your personal bank against the rates and programs from other lenders. Ask your friends and family who’ve recently remodeled to see if they have recommendations.
Be thorough and diverse in your research! Don’t forget to check trade unions and smaller local banks to see if they have better products or perks available. In the Portland area, Umpqua and Key Bank in particular are known for having really good home remodel financing options and may be worth checking out for your situation. It may also be worthwhile talking to one or two mortgage brokers; they have access to multiple lenders and may have other financing options not available at the smaller banks. They can also usually get better rates.
Be careful not to bite off more than you can chew. Just because one lender offers you a bigger budget doesn’t necessarily mean it’s the best option; do your own due diligence with your budget and situation, know how much you can really afford to borrow and comfortably pay back, and always read the fine print. Know what the terms and penalties are and make sure there are no hidden surprises. Ask a lawyer or a financial consultant to help you decipher contracts and review your situation if you aren’t feeling totally confident.
How to choose a lender
The process may be a little different depending where your loan comes from, so think about your comfort and experience levels dealing with lenders and your finances, and decide what type of encounter you’d like to have.
Big banks can sometimes feel transactional – your bank contact clocks out at 5pm and won’t be around for questions if you need help after that; he likely has a lot of other clients, and it can feel like you’re a sheet of paper in his portfolio; and sometimes he’s done so many of these that he isn’t anticipating your questions or understanding of your uncertainty. That being said, if you aren’t expecting trouble with financing, don’t want any hand-holding, and you’re doing a pretty standard remodel or addition, larger banks usually have systems in place to make the process quick and easy, with minimal hiccups and competitive interest rates.
If you don’t have a perfect financial picture (many people don’t!), the smaller banks and brokers are likely going to be an easier route for financing. Once you build a relationship with the lender, they’ll often work harder in your favor to get your project valued correctly and get your financing approved. Look for lending teams with in-house underwriting and appraisals; these lenders may be able to offer what they call “portfolio loans,” which are held in-house rather than sold to a third party. The portfolio loans can be a little “riskier” since they don’t have to be packaged for sale, so these lenders can sometimes offer loans to people with less-than-perfect credit or finances that wouldn’t otherwise qualify.
There are a lot of great lenders out there. Ask for referrals! Who have your friends used? Does your designer or builder know someone great? Usually they’ve worked with a few different lenders and can give you an idea of where to start. Check online for reviews and rates, and make appointments to talk to a few different types of lenders. Like a lot of other things in life, having a good connection and getting a good gut feeling about a place or person often translates to a better experience. When in doubt and faced with a few very similar options, choose one you like best and click with. You’re going to be working closely with this person during the process and want someone who responds to your questions quickly, stays in communication, will anticipate and head off problems before they come up, and is easy to work with.
What the lending process looks like
The lending process will be different depending on what type of financing you’re getting, but the biggest thing to remember is that the financing process can take a long time. It’s best to start thinking about financing and talking to lenders before you need the funds, early in the process as you’re deciding what you’d like to do with your house. Once you find a lender you like and ask about the financing options they have available and the rates they charge on the funds, they can help you figure out what the next steps are and what you need to do. Here’s the general process in a nutshell:
HELOC, Home Equity Loan, or Cash-Out Refinance: you’ll submit an application with the required documentation, and then the lender will order an appraisal to determine what your home is currently worth. He’ll then calculate the equity you have available (current home value minus what you owe), will determine the max amount you can borrow (up to a maximum Loan to Value ratio that is determined by your credit profile), figure out the other details like terms and rate, and then you’ll sign and close. The money is yours to do what you like with, and you’ll repay according to the terms of your loan.
Fannie Mae HomeStyle loan: this is similar to a typical refinance, except the lender will calculate the new mortgage amount based on your home’s value after renovations. You’ll submit an application and get approved (be prepared with a credit score over 620 and 5% down plus fees); your certified contractor will submit a cost estimate detailing the work you’re planning to have done; the lender approves the work, closes the loan, and then will hold the funds in an escrow account and pay your contractor as the work is completed.
The FHA 203(k) loan: there are two versions of this one. The “Limited” loan is capped at $35,000 and intended for repairs and cosmetic improvements. The “Standard” version can be used to finance much more extensive remodels with larger budgets, and requires you to pay for a HUD consultant to oversee every step of the construction process. For either version of the loan, you’ll first decide what you want to remodel and have detailed plans put together; find your contractor and get fully developed bids; apply for the loan, go through the underwriting process, get approved, and close the loan (with a minimum credit score of 620 and 3 1/2% down). You’ll then work with the contractor and the HUD consultant to obtain permits and complete the work within 6 months of closing. Your lender and consultant will inspect the progress and approve contractor draws as work is completed.
Once you know how much money you’ll have available for your remodel, be up-front with your designer and builder about your max budget! They can tell you right away if what you’re wanting to do will be possible, or if you need to adjust your scope and your expectations to better fit your budget.
There you have it!
There’s no way around it, remodels are expensive and the financing can be tricky, but the investment is often worth it for the improvement in your family’s quality of life and the value you’re adding back into your home. Getting your ideas narrowed down and your design worked out is a really good first step; with your plans on paper you can get bids and know what that big scary number really is, which can help you dispel the uncertainty and get started on figuring out a plan to make your remodel dreams a reality.
Are you ready? What’s holding you back? Shoot me an email so I can answer your questions and help you move forward confidently in the direction of your dreams!