How to Obtain a Loan for a Home Addition

How to Obtain a Loan for a Home Addition

How to Obtain a Loan for a Home Addition

If your starter home is starting to feel a bit snug, it might be time for a home addition. Whether you need a new bedroom, bathroom, kitchen or other room, you’re going to need to finance the addition. Loans are a practical way to fund your home improvements. Additions add value to your property, so they’re a good investment. To obtain a loan for a home addition, you’ll need to find out the cost of your addition and review your financing options.

Determine the Cost of the Addition

To determine the cost of your home addition, contact two to three reputable contractors. Have each contractor put together a bid for the addition that breaks out all the costs. Compare the bids, keeping in mind your experience when meeting with each contractor. Decide which contractor you’d like to work with and add 10 percent to his bid. Your loan should cover the costs as determined by the contractor with a 10 percent cushion for emergencies.

Assess Your Financial Situation

Your loan options will be determined by your credit score, how much you need to borrow and how much debt you currently have. If you have a low credit score, you may want to work on improving your score before starting work on your addition. You can improve your score by paying down debt and making payments on time. You may also want to consider having someone with better credit co-sign your loan. Keep in mind that if someone co-signs and you stop paying the loan, that person is responsible for making payments.

Review Your Loan Options

Once you know how much your addition is going to cost and you have a sense of your financial situation, meet with potential lenders. These may include your bank or credit union or a mortgage broker. Your options may include a home equity loan or line of credit, mortgage refinancing, a personal loan or a federally-backed loan.

Home equity loans are a second mortgage. You borrow against the equity in your home, which is the value of your home minus the amount of your mortgage. If your home is valued at $200,000 and your mortgage balance is $100,000, then you have $100,000 in equity in your home. You can typically borrow a larger amount with a home equity loan, but if you fail to make payments, the bank can foreclose on your home. Home equity lines of credit are similar, but you can borrow smaller amounts over time. The maximum amount you can borrow is usually equal to the equity in your home.

You may also qualify for mortgage refinancing. This means you borrow more than the mortgage is currently worth and use the difference to fund your addition. This new mortgage replaces your original mortgage. Like any mortgage, your home is collateral for the loan, so if you don’t pay, the lender can foreclose on your house.

A personal loan may also be an option, especially if you have a good credit history. Personal loans are typically for smaller amounts, but they aren’t secured by your home. Since they aren’t secured, you may have a higher interest rate for a personal loan than for other financing options.

Depending on how much you need to borrow, a federally-backed Title 1 loan may also be an option. Title 1 loans are for improvements that are practical, so they can’t be used for luxuries such as a swimming pool. The maximum you can borrow with a Title 1 loan is $25,000 for a single-family home.

Tip

  • If you plan to do the work yourself, calculate an estimated cost based on materials and equipment then add about 30 percent to cover incidentals and unexpected costs which always find their way into the mix. (Reference 2)

Warning

  • A low credit score or poor income to debt ratio may prevent you from getting the loan you need and the home addition you want. As a rule, lenders will only lend up to 80 percent of the total value of a home as a home equity loan or line of credit. For second mortgages lenders typically require that your total debt is no more than 42 percent of your income per month.

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About the Author

Melinda Hill Sineriz is a freelance writer with over a decade of experience. Her work has appeared on Pocket Sense and Sapling. She specializes in business, personal finance, and career writing. She has worked in insurance sales and financial planning, helping families to manage their money and prepare for the future. Learn more about her and her work at thatmelinda.com.