Sunday, April 29, 2012

What Is The Best Financing For Home Improvement?

Even though you've done an excellent job in describing your situation, a solution isn't clear-cut. Your goal should be to minimize your total interest expense over a time period that allows you to pay off the loans while meeting your other financial goals. How you can do that depends in part on your lenders' willingness to work with you and your attitude toward interest rate risk.

What Is The Best Financing For Home Improvement?

Let's discuss the pros and cons of three options, along with some variations on these options:
  1. Ask the lender to increase your home equity line of credit to $235,000.
  2. Do a cash-out first mortgage refinancing.
  3. Pay off the first mortgage with the available balance on your home equity line and then finance the home improvements with a new home equity loan.
If you are able to increase the credit line to $235,000, you will have enough to take on the projects, you'll hold on to the low interest rate on the debt, and you shouldn't have to pay much, if any, in closing costs on the change to the loan. But the lender has to be willing to work with you. And note that you'll be hanging onto the risk that the line's interest rate could head higher in the future because it's based on the prime rate. You can manage that risk by aggressively paying down the loan balance.
A cash-out refinancing will pay off your existing first mortgage plus release money for your home improvements and repairs. The home equity line lender may have to agree to the refinancing. If it has to agree and won't, then you can look into refinancing both the first mortgage and the line of credit. The bad news is you will lose the low rate on your home equity line. You'll also pay the higher closing costs associated with a first mortgage. The good news is you will no longer face the interest rate risk on the line of credit, and you'll be locking in at near-historic low rates on mortgage loans.
Finally, you could look at taking out a home equity loan as a third mortgage. It's called a third mortgage because it's third in line to be paid in the case of foreclosure. It won't be a third for long because you'll pay off the first mortgage with the loan proceeds and have money to pay for your household projects. The closing costs should be minimal, but the interest rate will be higher than they are on your existing first mortgage. You'd take this approach if you wanted to hold on to the home equity line and if that lender won't sign off on the cash-out first mortgage refinancing.
It's difficult to come up with definitive solutions when you incorporate an adjustable-rate loan into the equation. You know your needs and comfort levels more than I could ever hope to. Which approaches are the lenders willing to discuss, and how willing are you to take on the risk of higher interest rates in the future to hold on to relatively low adjustable-rate debt over the next few years? Talk over these options with your lenders, and the best home improvement financing approach will rise to the surface like cream.

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