Compare 8 home improvement financing choices

Improvement projects finally make comeback

By Dana Dratch

If you're making home improvements in 2010, you're part of a group that is poised to spend more than $121 billion.

Will that be cash, credit card or loan?

8 HOME IMPROVEMENT FINANCING OPTIONS

Improving your home? Nail down how you'll pay for it first. You'll likely pay in one of eight ways: Cash Credit card Personal loan Home equity loan Home equity line of credit Cash-out refinancing FHA remodeling loan Contractor financing AT A GLANCE: Pluses, minuses, what they're best suited for

For the first time in four years, homeowners in 2010 are expected to spend more on remodeling projects than they did the previous year -- by almost 5 percent, according to numbers from Harvard University's Joint Center for Housing Studies. It's one more sign that the struggling housing market could have hit bottom, says Kermit Baker, a senior research fellow at the center and director of its Remodeling Futures Program.

Just as contractors match the right tool to the job, savvy homeowners match the size and scope of the project to the right sources of financing.

Today's homeowners are using all the old favorites, including cash, cards and a variety of home equity-based loans. And some are tapping  into a few lesser known options, such as FHA remodeling loans and contractor-sponsored financing.

"Most important, what is the amount of money you need to do what you're going to do?" says Jack Guttentag, professor emeritus of finance at the Wharton School and author of "The Mortgage Encyclopedia." "And how much equity do you have in your house? Because that's going to determine if you can borrow against your house or borrow against it at a reasonable price."

No. 1: Cash
When it comes to home renovation, cash is king. It's the low-stress option, with no pesky fees, contracts, interest rates or looming debt.

These days, 80 to 85 percent of homeowners are paying cash for renovations, says Baker. Historically, that number falls in the mid-60 percent range, he says.

If you use loans, credit cards or anything other than cash, the big question to ask is "do you need this additional debt?" says Doug Borkowski, director of Iowa State University's Financial Counseling Clinic.

No. 2: Credit cards
With credit cards, "most people underestimate how long they're going to carry that loan," says Josh Frank, senior researcher with the Center for Responsible lending. And if the worst happens, financially, and you miss a few payments, penalty rates are running about 30 percent, he says.

APRs on low interest credit cards are running at about twice the rate of home loans and refis. If you do opt to charge, use the card itself and not the cash advance feature which sports an extra fee and, very often, a higher interest rate, says Frank.

No. 3: Personal loans
Depending on your relationship with your bank or credit union, you may also be able to get a small, unsecured loan. Often called personal loans or signature loans, they are still around, says Michael Fratantoni, vice president of research for the Mortgage Bankers Association. But "it's been a very small business for some time," he says.

Rates can be a little lower or higher than those on credit cards, says Steven Rick, senior economist with the Credit Union National Association.

No. 4: Home equity loans
Standards are tighter now for any type of loan that involves home equity. Lenders want to see excellent credit scores, and the maximum amount many will loan (including other mortgages) is 90 percent of the home's value, says Fratantoni.

Home equity loans typically offer fixed rates for fixed terms that run from 10 to 15 years, with rates "about a point above a regular mortgage," says Fratantoni.

And that's the option many home equity borrowers are selecting. "A variable rate can't adjust much lower and could only go up," says Joe Ridout, consumer services manager with Consumer Action. Also, "the larger the project, the more attractive a fixed rate will be."

And with a fixed rate, "you can budget for this," says Evan Fuguet, senior policy counsel for the Center for Responsible Lending. "You know exactly what it's going to cost."

No. 5: HELOC
A home equity line of credit (HELOC) also siphons home equity, but instead of getting a lump sum, you're approved for a set amount and take it as you need it. HELOCs are popular with lenders and, in many cases, they will pay the fees associated with the loans, says Rick.

One concern for HELOCs: Be certain that the rate you're considering  is not just the introductory rate, says Guttentag. "Ask 'What is my permanent rate?'"

And if you're considering an adjustable rate HELOC, you "really have to make sure that you can handle any payment shock that comes your way," Fuguet says. Toward that end, ask plenty of questions, find out just how high that payment could grow and calculate the total cost of the loan. "You have to protect yourself," he says.

No. 6: Cash-out refinancing
One option homeowners sometimes use is a cash-out refinancing, in which people take some equity for improvements and give themselves a home loan do-over.

But if you can't better your current interest rate, then "99 percent of the time," you're better off with a home equity loan, says Guttentag, whose website has a calculator to let you compare the two options. 

What you want to see: one percentage point or better than what you already have, says Rick. Figure in all your fees and expenses "and do a cost-benefit analysis," he advises. "What is the opportunity cost of the cash coming out? If I use it to build a new bathroom, what is my payoff versus investing in some other asset?"

Currently, it's not a popular choice, says Fratantoni. "We're seeing very little cash-out activity," he says.

No. 7: FHA remodeling loan
Two lenders you may not have considered: the government and your contractor.

The Federal Housing Administration's (FHA) remodeling loan program is fairly small -- 3,854 loans last year -- but it can be a good deal for consumers. It doesn't require a specific amount of (or any) equity in the home. Owners can borrow up to $25,000 for up to 20 years for single family homes. Loans over $7,500 are secured with the home itself.

The lending banks and credit unions set the lending standards and may require a certain amount of equity. They can also charge fees, including a 5 percent origination fee, but most don't, says Lemar C. Wooley, spokesman for the U.S. Department of Housing and Urban Development. Projects are limited to a set (but broad) list of improvements. HUD's website includes a lookup tool for FHA lenders.

No. 8: Contractor financing
In addition, some contractors are offering financing services, says Bill Simone, president of Los Angeles-based Custom Design & Construction and former president of the National Association of Home Builders Los Angeles Remodelers Council.

With contractor loans, terms will vary widely. What you want: a fixed rate, no points and no junk fees, says Simone. Rates "depend on a client's credit," he says. For example, his company's loan rates are from 5 to 11 percent.

When your lender is your contractor, it's doubly important to vet him in both roles. Check with past clients, the state consumer affairs office and do an online search that includes the Better Business Bureau, your state and local government's licensing offices and the local newspaper.

See related: Glossary: Credit-related terms homeowners should know, A primer on personal loans, Compare reward credit cards

Published: June 7, 2010

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