Adding livable space to your home improves the value for your family, and as a homeowner an addition will strengthen the value of your investment. But how do you pay for your addition? Unless you are prepared to wait and save to pay with cash, leveraging the equity you already have in your home to pay for your addition is an option worth considering. Keep in mind that there is not one solution for everyone. The best option for financing your addition project using your home equity will depend on several factors. Consider carefully your financial situation, credit score, current interest rates, and your evaluation of the advantages versus the disadvantages of each of the lending options before making your decision.
Mortgage refinance
A mortgage refinance could free up enough cash to pay for your home addition. Refinancing your current mortgage is an opportunity to pay off a higher interest loan with a new lower interest loan. The new mortgage loan is for the amount of principal remaining on your current loan, so your monthly payment will be lower.
Advantages of a mortgage refinance
- Leverage your home equity to get a lower interest loan with a lower monthly payment.
- Use this opportunity to shop for the best new loan available to you.
- A lower monthly payment means more cash for you to save, spend, or invest while paying off your new mortgage.
- If you have enough equity, you can avoid paying Private Mortgage Insurance (PMI) on the new loan.
- Paying for your addition with this option does not add another monthly bill.
Disadvantages of a mortgage refinance
- Fees and closing costs are paid to the new lender when you sign for the loan.
- If your credit score is low or your debt is high, you may not be able to get a better loan.
- If the interest rate on your current loan is lower than today’s interest rates, refinancing may not be an advantage for you.
- Saving the money to pay for your addition using the difference in monthly mortgage payments may take several months.
Cash-out refinance
A cash-out refinance is effectively exchanging most of the equity you have established in your home for cash to build your addition. This type of loan is similar to a mortgage refinance in that your existing mortgage is paid with a new mortgage loan. With a cash-out refinance, however, the new lender gives the homeowner a check equivalent to a portion of existing home equity. You are, essentially, cashing in your home equity for the funds to build your addition. It is important to research your options for a cash-out refinance because interest rates, fees and options vary. Most lenders limit the loan amount to 80% to 90% of your current property value.
Advantages of a cash-out refinance
- Lower interest cost over the life of the loan if your refinance is at a lower interest rate.
- Potential additional funds for other home repairs and expenses.
- Using the cash to increase the value of your property with an addition is a solid investment in the future.
Disadvantages of a cash-out refinance
- New loan terms should be read carefully. Rates and fees tend to be higher for this type of loan.
- Fees and closing costs are paid to the new lender when you refinance.
- If the new loan is for 90% or more of the home’s equity, you may have to pay PMI again.
- Experts warn that cash-out refinancing with a 30 year loan leads to an increased risk of foreclosure for homeowners that may be unable to make the loan payments for the increased length of time.
Home equity line of credit
A home equity line of credit (HELOC) uses your home equity as security for a loan that is paid back over a period of time with monthly payments. Using this flexible method to pay for your home addition adds a monthly payment to your bills, but also gives you the option to renovate or repair your home over time up to a limit similar to a credit card. Generally, HELOCs offer a 10 year draw period with minimum payments where a homeowner can borrow for projects like your addition, followed by a pay back phase over 15 to 20 years. The credit limit of a HELOC is usually 80% of your home’s value minus the amount you still owe on your mortgage.
Advantages of a home equity line of credit
- Low cost to get started.
- Only pay interest on the amount of money used.
- If you have good credit and sufficient equity, a home equity line is used to improve the investment in your home without needing to refinance.
- The interest paid on a HELOC may be tax deductible as long as you used the funds to pay for home improvements like an addition.
- Flexibility to pay for expensive repairs and renovations that you may need over time.
Disadvantages of a home equity line of credit
- A HELOC is a new monthly expense.
- There are fees to apply for a home equity line of credit.
- If you need a small amount of money, a HELOC is not the best solution.
- Monthly payment may change due to variable interest rates.
- Some homeowners are tempted to use their home equity line for cash to pay for items such as high interest credit card debt that do not increase the value of their home. This can create a situation where a homeowner is at risk for owing more than their home investment can repay.
- The HELOC is a secured loan backed by your home which increases the risk of foreclosure.
Home equity loan
Using a home equity loan to pay for your addition takes advantage of the equity you have in your home to improve the value. As with other home equity options, the amount you can borrow is determined by your credit score, the difference between what you owe and the value of your home, and a cap that is generally 80 to 90% of the current value of your home. This type of loan gives you a lump sum of cash for improvements like your addition, and is best used to improve your home investment.
Advantages of a home equity loan
- Home equity loans are a fixed rate loan so you know what to expect for monthly payments.
- Keep your current mortgage. You may want to keep your current mortgage because of a low interest rate or other incentives.
Disadvantages of a home equity loan
- Borrowing against the value of your home always carries the risk of foreclosure.
- Home equity loans are a second mortgage, and can have higher interest rates than other home equity options.
Advantages of Improving Your Home
Your home is an investment, and naturally you want to make the most out of that investment with the resources available to you. The best return on investments for home renovations are improved curb appeal, updating with new light fixtures and paint, and adding living space such as a new master suite or new bathroom addition. While considering your home equity financial options, keep in mind that it might be an advantage to invest in some curb appeal and other room updates as well as your new addition.
Not all room additions are about improving the monetary value of your home. Changes are about improving the space for you and your family. Building a mudroom, for example, may not increase the value of your home for resale as much as it increases the functionality and happiness for your family. Whatever space in your home you want to renovate, or any addition you want to build, Designers Northwest offers design services with 3D walkthroughs. Get in touch with us today, and we will help you turn your home into your dream home.