Whose Money to Use
Types of Financing Available
There are many ways to obtain financing for your home
improvement project. Here are just a few (in order of popularity):
Home Equity Loans
These are the most popular loans for home remodeling. They are
tied to the equity in your home and may be tax deductible. Most are
available at competitive interest rates. There are two types of home
equity loans: line of credit and lump sum. In a line of credit loan,
you and your lender set a maximum amount of money that you can draw
upon during the course of your project. This allows you the
flexibility of withdrawals. You can make your withdrawals as needed,
and you are only obligated to repay the amount of money you
withdraw, plus interest. However, be aware that the interest rates
on line of credit loans are frequently pegged to the prime rate and
can change any time prime changes, or even more frequently. A lump
sum or installment loan is a one-time lump sum withdrawal of a set
amount, which you repay in monthly increments usually with a fixed
interest rate. The sum is based on the equity you have in your home.
Equity is the value of your home minus the outstanding balance on
any mortgages. The amount of equity required depends on the
particular lender program.
WARNING: If you cannot repay a home equity loan, you could
end up losing your house.
Refinancing
When you refinance your home, you are in effect obtaining a
larger mortgage to pay off your existing mortgage. The excess funds
can be used to finance your home improvements. The big drawback is
that refinancing often costs between 3-5 percent of the loan amount
and can take as long as getting approval for a first mortgage. This
type of financing only makes sense if you were already planning to
refinance your home or if you can obtain a much lower interest rate
than you are currently paying.
No Equity Loans
Some lending institutions offer loans to homeowners who do not
have sufficient equity in their homes to get a home equity loan. No
equity loans offer a range of benefits and loan amounts and can work
as a consolidation loan to lower your overall debt. The big benefit
is that these loans usually are tax deductible.
FHA Loans
The Federal Housing Administration (FHA) began Title I financing
for property improvements under the National Housing Act of 1934, a
program that is still available today. The FHA makes it easier for
consumers to obtain affordable home improvement loans by allowing
loans up to $25,000 without any equity in the home.
Margin Loans
Loans against securities you own are the next cheapest source of
funds after home equity and no equity loans. With a margin loan,
some brokers will let you borrow up to 50 percent of the value of
your stocks and up to 90 percent on U.S. Treasury securities. The
interest rates are also competitive. In addition, you may deduct the
interest against investment income (but not against ordinary earned
income). WARNING: There is a risk attached to these loans-if your
stocks go down in value, you will be called upon to deposit more
money into your account (known as a margin call). If you cannot come
up with the money, you will be forced to sell your stocks when the
market is low.
Personal Loans
There are many types of personal loans available: debt
consolidation; unsecured lines of credit based on your earning
capacity or net worth; and lines of credit secured by a possession,
such as a car or a savings account. The interest rates for personal
loans depend on the borrower's credit and what is used for
collateral. For example, loans using savings accounts as collateral
may be priced as low as 2 percent above the savings/CD rate.
WARNING: Remember that accounts used as collateral will not
be available for other purposes.
Loans from Retirement Plans
You may be able to borrow against a defined-contribution
retirement plan, such as a 401(k) or company profit-sharing plan,
depending on where you work. The availability and terms of these
types of loans will vary from employer to employer. Usually, if a
company allows these loans, you can borrow up to half of your vested
balance or $50,000, whichever is less. You will be required to repay
the loan in full within five years or if you terminate your
employment. The interest on these loans is not tax deductible.
WARNING: There are significant IRS restrictions on these types of
loans. If you do not follow the rules and restrictions, you may be
faced with a 10 percent penalty fee, plus income taxes on the money
you borrow.
Life Insurance
If you have a whole-life or other cash value insurance policy,
you can borrow against that policy. The death benefit will be
reduced by the amount of the loan. If you die before the loan is
repaid, your heirs will receive the face value of the policy less
the outstanding loan balance.
Credit Card Loans
These are as quick and easy as visiting your local bank. Your
credit card will determine the amount of money you can borrow and
what interest rate you will be charged.
WARNING: As easy as this is, it is one of the most expensive
ways to borrow and should only be used if you need money quickly and
plan on repaying the loan just as quickly. The interest rate charged
is usually quite high. |
