How to Add Remodeling to Your Mortgage

Financing a remodeling project doesn't have to be difficult.

Financing a remodeling project doesn't have to be difficult.

When you accept a mortgage loan from a lender, you are agreeing to specific terms regarding the total amount of money to be borrowed, the length of time in which repayment will occur, the size of monthly installment payments and the rate of interest. Lenders attach very specific terms to lending offers to ensure that borrowers are fully aware of what is expected of them to avoid foreclosure. Certain situations may arise where you need to borrow additional funds for home remodeling projects. Depending on the amount of equity you have established in your property, you may be able to secure additional funds.

Tip

Financing a remodeling project doesn't have to be difficult. You can use a home equity fixed-rate loan or home equity line of credit to ensure that you have the funds you need to complete your remodeling projects.

Mortgage Financing and Equity Basics

As you begin to make payments on your mortgage, the money you pay toward the principal of your loan is transformed into equity. You can think of your equity as the portion of your house you actually own at any given time based on the percentage of your mortgage balance you have paid back. For example, if you have paid $25,000 of your principal balance on your mortgage, you would have $25,000 of equity in your home. Or, if you have paid 20 percent of the home's value as a down payment, you would begin your mortgage payments already having established 20 percent of the current value of the property as equity.

Where the topic of equity becomes particularly important is in situations where your property's value changes. For example, if you have 20 percent equity established in a property that you agreed to purchase for $250,000, your equity stake would increase to 50 percent in the event that the property value soared to $500,000.

Perhaps the most important concepts to understand regarding your equity are A.) that this figure is representative of your actual ownership of your property rather than the lender's ownership and B.) that your equity is fundamentally linked to your property's current value.

Adding Home Improvement Loan to Mortgage

Just because you have established equity in your property does not mean that this equity is off-limits for further investments. In fact, a variety of loan opportunities are currently available to homeowners who have established equity in their property and are willing to use it as collateral against additional borrowing.

A home equity loan is arguably one of the most popular means for deploying home equity. When discussing home equity loans, it is necessary to distinguish between the two commonly used formats of home equity loans available today: fixed-rate loans and the often requested HELOC, or home equity line of credit.

Exploring Fixed-Rate Loans

When an individual applies for a fixed-rate home equity loan, they will receive a lump sum payment from their lender that is equal to the amount requested up to the designated limit based on their current equity status. After receiving this lump sum, the borrower will generally be given between five and 15 years to repay the sum in question. Of course, interest will be attached to this repayment term, meaning it is in the best interest of the borrower to repay the funds as soon as they are able to do so.

In the event that the recipient of the home equity loan decides to sell their property during the repayment period, they must repay the full sum of the home equity loan before they will legally be able to sell the property.

Typically, fixed-rate loans will carry a relatively low interest rate, making them an excellent tool for financing investments that could improve the value of your property, such as a home remodeling project.

Understanding Home Equity Lines of Credit

A HELOC is similar to a fixed-rate home equity loan in the fact that the money loaned to the borrower is the equivalent of the equity they have already established. That being said, the means by which the borrower receives these funds is altogether different.

When a borrower is approved for a HELOC, they are given access to a revolving credit line. The borrower can withdraw funds from this credit line, as well as pay back into the credit line as needed, over a span of five to 10 years. This window of time in which withdrawals can be made is commonly referred to as the "draw" period.

When the draw period comes to a close, the borrower will enter a repayment period lasting between 10 and 20 years. Unlike fixed-rate loans, a HELOC will often carry a variable interest rate, the terms of which will be disclosed to the borrower prior to accepting the loan. Whereas a fixed-rate loan may be preferable for individuals who have a specific purchase or investment in mind, a HELOC allows for a greater degree of flexibility.

Financing Home Remodeling

Both fixed-rate loans and a HELOC can be viable options for financing your home remodeling project. If you feel confident that the remodeling will raise the value of your property a significant amount, there is little reason not to take advantage of the low interest rates attached to equity loans to make this happen. You may decide that it is in your best interest to use a home renovation loan calculator, such as the one provided by Home Improvement Loan Pros, to gauge the size of loan you may require and the types of payments you can expect over the next several years.

When you enter the repayment period for a HELOC or begin making payments on your fixed-rate loan, it is critical that you realize that these payments will be in addition to your standard mortgage payment. You should not enter into this borrowing arrangement if this expanded monthly payment will stress your finances beyond a sustainable level.

While home equity loans are an often-used form of borrowing, it is very important to remember that they carry their fair share of risks, particularly in the event that you are unable to make the required payments. By agreeing to a home equity loan, you are essentially using your property ownership as collateral. Failure to repay the loan will result in the loss of your property.

Ask the Financial Experts

If you are looking to find the best way to finance home improvements, your first step may be to consult with a financial adviser. Given the significant implications of borrowing additional funds on top of your mortgage, it is in your best interest to ensure that you have explored all possible options before settling on a plan. A financial expert or lending officer could provide you with additional insight that will help inform your decision and ensure that you have explored all necessary perspectives on the matter.

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About the Author

Ryan Cockerham is a nationally recognized author specializing in all things innovation, business and creativity. His work has served the business, nonprofit and political community.