There Are a Few Different Types
There are a couple of different types of loans that you can take out for home improvement. The most common one is a home equity loan, which is a second mortgage for a fixed amount of money that is secured by the home itself.
You will make payments monthly over a fixed amount of time, in the same way as your original mortgage was set up. If you don’t pay the loan though, the lender can foreclose on your house in order to recuperate losses.
Another route is a personal loan, but for a large sum of money, you may find yourself putting up your house as collateral anyway. Despite this, sometimes you can get an unsecured personal loan if you have excellent credit, thereby leaving your house out of the equation. You'll need to compare the best personal loans and see if the rates make sense for you.
Home Equity Loans
Typically, you can borrow up to 85% of the value of your home with a home equity loan. This is the total loan to value ratio.
However, some lenders out there, will allow you to mortgage the value of your home up to 100%. As an example, if you originally bought a home for $200,000 and have paid $50,000 of the mortgage off, you now have $50,000 in equity and a loan balance of $150,000. (This of course assumes that the house value hasn’t changed.)
In this scenario, a lender will typically allow you to borrow up to 85% of the value of your home, or $170,000. After subtracting what you owe on the mortgage, this allows $20,000 to be available in equity left to borrow.
Obviously, your credit history will come into play as well, as well as your stated income. There is a long process involved in getting a home equity loan, but it should be noted that they typically are easier to qualify for than the original mortgage, as there is something of value and collateral that the lender can take possession of, in the event of a default.
Most of the time, home equity loans will have fixed interest rates. This means that the rate stays the same over the entirety of the loan, so your monthly payments will stay the same.
However, home equity loan interest rates are typically a little bit higher than the original mortgage rates. Most lenders will start with a benchmark rate, quite often the primary set by the Federal Reserve, and then adjust your rate based upon things like your credit score, income, and of course, the existing mortgage balance.
There will also likely be many fees attached to these loans, starting with the application or origination fee. This basically covers the cost of processing the loan and is quite often less than $100. There is also the appraisal fee, which can be as high as $1,000 if they need to send somebody out to appraise the value of the home.
Beyond that, there are other things you have to pay for, such as title search and insurance, credit report fees, and notary charges. There are also closing costs, and of course late fees, if you run into that situation.
This will all be rolled into your new loan so be aware that these costs exist and that you fully understand what they are and how they may impact your home improvement budget.
Some of the Advantages of a Home Equity Loan
One of the major advantages of home equity loans is they typically have a lower interest rate than other financing alternatives, such as credit cards. This is because there is less risk to the lender because you are putting up a huge piece of collateral. Because of this, a home equity loan makes much more sense than a credit card when it comes to replacing that roof, or even remodeling the bathroom.
A home equity loan will typically allow for a larger amount of capital to be financed, as personal loans quite often have a “ceiling” attached to them, somewhere around the $50,000 level. Depending on the situation with your home, you may find that you can borrow much more than this, under the right circumstances.
Tax deduction is also possible as the interest you pay for your home equity loan can be tax deductible. This remains true as of 2018 if you have a combined first and second mortgage debt below $750,000. This can make these loans attractive.
Some Risks of a Home Equity Loan
Like anything else, there is the possibility of downsides to this financial product. One of the first things you need to pay attention to is that you are reducing the equity of your home, thereby limiting the borrowing power that you initially enjoyed. Because of this, homeowners should be diligent about the need to take out a home equity loan.
There are also the long-term payments that you have just signed up for, creating a second mortgage. Beyond that, you are securing the debt with your home itself, putting it at risk. Again, be cautious, but recognize that this financial tool can be very useful in the right circumstances.