Paying for Home Improvements

When you buy a fixer-upper, you expect to undertake significant home improvements. If you buy a house in good condition, remodeling and repairs may be the last things on your mind when you close the deal.

The urgency to make improvements later on may be prompted by a leaking roof, a change in the size of your household, or the need to convert the basement into the headquarters of a home-based business. You have a number of options to pay for improvements, including paying cash. However, most homeowners favor financing the job, especially if it involves significant remodeling or repair.

Leveraging Payback
A rule of thumb for financing home improvements is to match the loan type to the estimated resale value of the project. This means taking out short-term loans for projects that don't add significant value to the house, and securing long-term financing for improvements with definite payback value, such as remodeling the kitchen or building an additional bathroom.

The goal is to leverage the payback value. For projects with a lower payback value (such as adding a screened-in porch) it's best to have the project paid off before you sell the house. For projects that offer a significant return on your investment, you can choose long-term financing and pay it off when you sell the house.

Short-Term Options	Terms	Notes
Home equity line of credit	An open-ended, adjustable-rate line of credit for 75 percent to 80 percent of the home's value minus the balance on the mortgage.	A line of credit can be paid off and used again; most lenders do not require an appraisal or credit check. Interest is tax-deductible.
Personal loans	A short-term, fixed-rate note. Interest rates may be higher than home equity loans or second mortgages.	Interest is not tax-deductible.
Consumer credit	An unsecured, high-interest line of credit with no restrictions on use.	Avoid using consumer credit to pay for home improvements. It can be used for emergency repairs as long as you pay off the balance quickly. Interest is not tax-deductible.
Home equity loan/second mortgage	Fixed-rate, five- to 20-year loans for 75 percent to 80 percent of the home's appraised value minus the balance of the mortgage. Interest rates are slightly higher than a standard 30-year loan.	Closing costs may include appraisal, title search, credit check, application fee, and points; some closing costs may be rolled into the loan. Interest is tax-deductible.

Long-Term Options	Terms	Notes
FHA Title 1 loan	Fixed-rate, government-insured, 15- or 20-year loans that allow homeowners to borrow up to $25,000 to make non-luxury home improvements; no equity is needed for loans under $15,000; no security is needed in most cases for loans under $7,500.	Available only from FHA-approved lenders; call the local FHA office for a list of institutions your area.
Cash-out refinancing	Adjustable or fixed-rate 15- to 40-year loan for 75 percent to 80 percent of the home's appraised value. Depending on the balance of the original loan, the remaining cash from the refinancing can be used at the homeowner's discretion.	Some lenders will refinance up to 95 percent of the home's appraised value; interest rates will be higher. Closing costs may include appraisal and points; some may be rolled into the loan. Interest is tax-deductible.
Value-added mortgages	Adjustable or fixed-rate loans for up to 90 percent of a home's remodeled value (cost of remodeling rolled into loan).	Seek lenders familiar with this new form of home improvement financing, such as Fannie Mae (ask about HomeStyle loans). You'll need to produce remodeling plans and the name of your contractor when you apply.