Always start by looking at who you currently use for you financial needs. Does your current bank or credit union offer home improvement loans or unsecured lines of credit?
Your current bank or credit union knows how you do business and if you have kept your account in good standing, they are more likely to approve you with favorable rates and terms. Or at the very least, they may overlook a few blemishes because they are able to verify more information about you and your financial habits.
Despite promises contractors and lenders make in their ads and promotional materials, how much you can borrow hinges on:
- Your credit rating
- The loan-to-value ratio of your project
- Your income
Types of Financing.
Secured financing is collateralized, most often by your home. Secured loans are longer to process, require more paperwork, but offer the option of more flexible underwriting because the loan is protected. These loans take time to process and often times require an appraisal or review of your collateral.
Unsecured financing is based on credit profile and is essentially a loan on your signature. These terms are often shorter in length and based predominately on your credit score and proof of income. These loans are quicker to process and approvals come instantly.
A majority of financing nowadays is unsecured in the home improvement world. Secured financing has suffered over the years because of tightening credit standards and home valuation issues. Let’s examine some key factors to prepare you in the language of underwriting.
Be mindful of rate versus term and payment when choosing. Here is a simple chart:
Computer driven decision
Shorter terms and decent rates
Payments are generally higher than secured
Loan amounts up to $35,000
Generally require payoff in 5-7 years
No property lien
Payoffs up to 15 years
|Longer application and underwriting process
Longer terms, with the best rates
Requires collateral in the form of your home equity
Loans amounts up to $100,000 and greater
Payoffs up to 15 years
Requires a property lien
Because you probably have a mortgage on your home, any home improvement mortgage really is a second mortgage. Don’t be afraid of a second mortgage. When priced right and with a good lender, you can put together the right financing package to meet your home remodeling goals.
If your home is free and clear (meaning no mortgage), then you have ample opportunity to utilize your equity as collateral for a secured loan. If you have a mortgage, you really need to consider secured vs. unsecured financing. If you secure your improvement against your home, you will have a lien on your property.
Our best advice is to find aggressive unsecured financing with a lender that offers good payment rates and terms.
For an unsecured loan, all that usually required is:
Income Verification (with some lenders)
Other Loan Options
If you need collateral and have to use your home, here are the loan options:
These mortgages offer the tax benefits of conventional mortgages without the closing costs. You get the entire loan up front and pay it off over 15 to 30 years. And because the interest usually is fixed, monthly payments are easy to budget. The drawback: Rates tend to be slightly higher than those for conventional mortgages.
These mortgages work kind of like credit cards: Lenders give you a ceiling to which you can borrow; then they charge interest on only the amount used. You can draw funds when you need them.
Some programs have a minimum withdrawal, while others have checkbook or credit-card access with no minimum. There are no closing costs. Interest rates are adjustable, with most tied to the prime rate. Most programs require repayment after 7 to 10 years. Find out how high the rate rises and how it’s figured. And be sure to compare the total annual percentage rate (APR) and the closing costs separately. This differs from other mortgages, where costs, such as appraisal, origination, and title fees, are figured into a bottom-line APR for comparison.
These FHA insured loans allow you to simultaneously refinance the first mortgage and combine it with the improvement costs into a new mortgage. They also base the loan on the value of a home after improvements, rather than before. Because your house is worth more, your equity and the amount you can borrow are both greater. The usual term is 30 years.
Houses aren’t the only loan collateral. Stocks, bonds, certificates of deposit, a savings account, and even a pension or retirement account can also help you get a viable personal loan from many credit unions and banks. Although the interest isn’t tax-deductible, the rate can be low enough to make these loans enticing. You also save the usual title, appraisal, and other closing costs of a mortgage.
A Language That’s Easy to Understand.
There are many financial terms that you will come across when you try to finance a home remodeling project. We have provided some of these terms to help you along the way.
Annual Percentage Rate. The bottom-line cost of a mortgage, with all the up-front fees factored in with the base interest rate.
Fees paid with the down payment, such as origination fee, discount points, title insurance, appraisal, and credit report
Discount Points or Buydowns
A chunk of interest paid up front. Points compensate a lender making a higher-risk loan by increasing interest paid up front without a rate hike. One point equals 1 percent of the loan.
A homeowner’s interest in the property, determined by subtracting the loan balance from the appraisal.
Good Faith Estimate
A mortgage lender’s disclosure of all the expected costs before the closing of a loan
Line of Credit
A loan in which the borrower can draw more or less money (up to a certain limit) instead of starting at one fixed amount.
Loan to Value Ratio
The percentage of the appraisal of a home on which lenders base the size of a loan
Loan Origination Fee
A one-time fee lenders charge when they make a mortgage loan — usually 1 to 2 percent of the loan amount.
A loan that starts at one amount and is gradually paid off through fixed monthly payments for a fixed amount of time.
A loan source that does not represent one particular institution, but originates loans from many lenders
Principal, interest, taxes, and insurance, the main monthly costs of owning a home with a mortgage
Private Mortgage Insurance. Protects a lender from loss in case of loan default. PMI usually is required on loans with a loan-to-value ratio greater than 80 percent.
How Your Credit Impacts Your Financing Ability
The best rates and terms go to homeowners with an “A” rating — no late payments in the last 12 months and no maxed-out credit cards. One or two late payments or overdrawn credit cards probably won’t knock you out of the game, but you might end up with a higher interest rate and a smaller loan.
Credit requirements change from lender to lender. Over the course of time though, we have seen credit scores above 620 have the best chance of approval. Scores above 700 are considered “A” tier and receive the best rates and terms.
It is strongly recommended that you pull your own credit prior to inviting bids. This will help you see where you stand and what items may need help. It is also a good habit to stay on top of what is on your credit report. Sometimes, it can be the difference between paying thousands of dollars interest.
The following sites are trusted credit partners:
A rule of thumb for users…lenders aggregate credit reports and your score on these sites will probably be higher than your score pulled by the lender. Always remember, this just gives you an idea where your strengths and weaknesses are as a consumer.
Pull your own credit. Know your score. Be prepared.