2005-09-22 / Business & Finance

How To Finance Home Remodeling

The current boom in home values has several aspects. The first is - it is not countrywide, e.g., it is here in the New York metro area, in the big California cities and some other places. However, out in the heartland, it’s not happening.

The boom is great if you are selling your “big house” because the kids are gone and you can relocate into something much smaller. I have clients who have done exactly that. One couple sold their home for $875,000, paid off the remaining mortgage of $200,000 tax-free dollars to add to their retirement nest egg.

However, if you are selling your big house to buy another big house, the boom doesn’t help you much. You are incurring selling, moving, closing and buying costs and will find yourself in relatively the same situation after all is said and done. What is your alternative? Fix up your current house. This column is abut how to pay for home improvements that will make your current home your “dream house.”

One option is to pay with cash (which assumes that you have a sufficient amount). If you have the cash it certainly is an option. However, be-fore you plunk it down, consider this.

With today’s historically low interest rates, lenders are willing to give you money for a song. 30-year fixed rate mortgages cost less than 6%. 15-year loans are below 5%. Adjustable rate mortgages (ARM’s)are less than 4%. If you are in the 38% income tax bracket, the after tax cost of these loans is: 4.3% for a 30, 3.6% for a 15 and 2.8% for an ARM! It’s a borrower’s heaven.

Assuming that you can get an after tax return on an investment account greater than the above rates, your only complaint is that the lenders will only loan you 80% of your home’s value. Is this man saying that I should not try to maximize the equity in my home? Yes, he is.

The belief that having no mortgage is a good thing, and therefore you should build up a lot of equity in your home, comes form the Great Depres-sion, which began with the market crash of 1929 and ended with World War II. That was 74 years ago! Equity in a home won’t buy groceries. Equity in an investment portfolio will.

Getting back to the subject at hand, if you don’t want to invest your cash into your home, or if you don’t have the necessary cash, there are other alternatives. If you have built up equity in your home, a cash-out refinancing, home-equity loan or line of credit is likely to be your best source of financing.

With a cash-out, you refinance (“refi” is new jargon) your existing mortgage balance and borrow more. All of the interest is tax deductible, and as mentioned above, rates these days are fantastic. However, if you leave yourself with less than 20% equity in the home, you’ll probably have to get private mortgage insurance, which will raise your cost of borrowing.

Additionally, if your loan is more than $322,7000, you’ll fall into the jumbo-loan category and your interest rate could rise by as much as a fifth of a percentage point.

Another alternative for financing home improvement is a home-equity loan. This is a “Second” mortgage on your home. It is a fixed amount that piggy backs on your first mortgage and you pay monthly payments just like you do on your first mortgage. The reason that you might opt for a second mortgage rather than a refi is that the closing costs for a second mortgage are much lower than for a first.

A third alternative for funding home improvements is an equity line of credit. This vehicle gives you a line of credit with a dollar limit that you can access at any time. Your house secures any outstanding balance, so the payments are income tax deduc-tible.

You can use the money for home improvements or anything else that you want. Unlike a first or second mortgage, where your pay fixed rates for the life of the loan, with an equity line of credit you will pay prevailing interest rates usually based on 15-year loan. Right now these rates are at historic lows of about 4.5%.

The above covers a lot of material in a small space. A good resource for obtaining more information on home equity borrowing is the Web site Bankrate.com. Good hunting.

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