February 11, 2019
Later this week we’ll find out if the government can forge a budget deal and avoid shutdown. Regardless of what the government is up to, Orion’s brokers continue to be asked about financing a remodel.
If a client is looking for mortgage options to remodel their home, there are several options to consider. Most commonly used for paying for major home projects are cash, a home equity line of credit or fixed rate second trust deed, new primary loan with cash out, new renovation loan, or possibly tap other resources. In order to help a client decide which option suits their needs, there are some basic guidelines for the various financing options.
Depending on the scope of the project your client may have enough money saved to pay cash for the project. The obvious advantage is lack of any interest costs and monthly payments. Keep in mind that many remodel/renovation projects can end up costing more in time and money so remind clients to make sure they have enough to cover cost over-runs. A client may want to consider a home equity line of credit for a small amount to ensure they do not run out of funds during the project.
A HELOC is like a credit card: approved for a maximum amount of credit and then access as much of the funds as needed up to the credit limit with payments based on the amount of the outstanding balance. This gives your client flexibility based on how they use the funds available. The rates are variable, and the minimum payment due on most HELOCs is an interest only payment. Many borrowers fall into the habit of paying interest only which results in a large balance remaining on the loan. Orion encourages brokers to help consumers learn!
A fixed-rate second trust deed operates like a traditional fixed rate mortgage but because it is in second position the rate is higher than available primary mortgages at the time of the transaction. The advantage is the ability to budget exactly what the payment will be for the period of the loan and if your client’s current mortgage has a rate that is significantly lower than the current rate, they can retain that rate and payment. The disadvantage is many lenders restrict the LTV to 80% (same as most primary mortgages) and the higher interest rate.
It would be unusual to find a broker who doesn’t know what a cash-out refinance is. Your client refinances their existing mortgage and increases the amount borrowed to cover the funds needed up to the LTV allowed by the loan program. One advantage of the cash-out refinance is that a 30-year fixed rate has the pretty low rate and often the lowest possible payment due to the long amortization. And don’t forget a fixed rate throughout the term of the mortgage which enables your client to budget monthly housing payment with certainty. Disadvantages include making payments on funds that may be sitting in the bank waiting for the project to begin and through the finish. Another is the interest rate may increase from your client’s current mortgage rate. Also, a cash-out refinance is costlier than a rate and term refinance or a purchase transaction.
A renovation loan is a combination of a traditional fixed rate mortgage and a HELOC and can be used to purchase a home your client wishes to remodel or as a refinance of an existing home for major renovations. Ultimately, the existing mortgage will be paid off and the additional cost to remodel will be added. The excess funds are placed in an escrow account controlled by the lender to dole out funds as parts of the project are completed and verified. An advantage is your client has a 30-year fixed rate mortgage upon completion of the project and the rate is competitive with a traditional mortgage or cash-out transaction. A disadvantage for many borrowers is the process to get to loan approval, which is longer and significantly more thorough than the traditional approval process. Another disadvantage for some is the draw process where the contractor is not paid until certain completion points in the construction. Many contractors want funds before they start the process.
Some homeowners do their own version of the renovation loan by maximizing their funds available with a traditional 30-year fixed rate mortgage and then add a HELOC onto the property for additional funds referred to as a Piggy-back. The advantage of the fixed rate 30-year loan for the bulk of the funds needed combined with the higher LTV of the HELOC lets your client complete the project with the best of both options.
If your client is eligible for a reverse mortgage, it can be used for home improvements if you qualify and there is enough equity is in the property.
All of these choices are exactly why borrowers use Orion’s brokers: the chance to teach and add value!