Budget overruns: Refinance equity loans to finish remodeling projects
When home improvement projects go over budget
- When budgeting for home renovations, add a contingency reserve of at least 10 percent.
- You can refinance a home equity loan or a line of credit, possibly gaining lower interest rates.
- Refinancing an equity loan or HELOC is largely dependent on remaining home equity, as lenders won’t exceed loan-to-value thresholds.
- Obtaining unsecured credit, such as a personal loan, or using a credit card, are alternatives, but interest rates will be higher.
Home-improvement projects are a common reason to tap into your home’s equity. In fact, a 2016 study from the Federal Reserve Bank of New York showed that home improvements were the top reason for getting a home equity loan or home equity line of credit (HELOC), cited by half of the consumers surveyed.
But what happens if you’re in the middle of a kitchen renovation or a family-room addition when you learn your budget is off track? If you were relying solely on a home equity loan or HELOC to fund the project, can you ask your lender to give you more money?
Budget before borrowing
The dilemma of going over budget often can be handled before the project ever begins. Lenders advise borrowers to make a detailed plan of the renovation, separating needs from wants. Establish realistic costs and have at least one contractor estimate costs for each item. Then add in a contingency reserve of 10 percent to 25 percent to cover the unexpected, such as uncovering mold or faulty wiring that must be brought up to code. Home-improvement projects are known for being more expensive than originally planned.
Don’t forget to include the costs of any non-contractor items like furniture or decorations.
If you’re funding your project with a HELOC, don’t use more than you need as you’ll pay interest on the amounts withdrawn. However, a HELOC can be a practical product for a home-improvement project because you don’t have to borrow a lump sum. If your remodeling bid came in at $50,000, look to get approval for $60,000 to $70,000 to cover those extras and unexpected costs.
If you’ve already tapped into equity, there are a couple options to remedy the problem of an over-budget renovation, depending on the type of loan you have.
Home equity loans, or second mortgages, can be refinanced. Check first with the lender that approved your existing home equity loan to see if they can help. A refinanced loan may come with the benefit of lower interest rates. It’s also possible to refinance a home equity loan into a HELOC, which offers the flexibility of withdrawing funds at your convenience.
Having the ability to refinance is largely based on your loan-to-value (LTV) ratio, which measures your existing mortgage debt against your home’s existing market value. For example, say your home is worth $300,000, you have a mortgage balance of $150,000 and a home equity loan balance of $60,000. Your LTV is 70 percent ($210,000 divided by $300,000).
Although many lenders limit loan amounts to 80 percent LTV, others may go up to 90 or 100 percent if you have an excellent credit score and a low debt-to-income ratio. Keep in mind two potential drawbacks of refinancing: First, there may be a prepayment penalty if you’re closing your existing home equity loan within the first few years. Second, you could have to pay another set of closing costs, which may or may not be rolled into the new loan.
For homeowners with a HELOC, there are lenders that will help you refinance for a higher amount or allow you to open a second account. Refinancing your line of credit might be the best option, if it’s offered, as the lender may waive application fees or closing costs. However, if the lender has to close your existing HELOC, they may require a switch to an adjustable-rate loan that does not have an interest-only payment period. One of the major benefits to most HELOCs is the interest-only period for the first five to 10 years.
You may be able to get a second HELOC, but there aren’t many lenders that offer this option. Again, if you have a high credit score, low amounts of debt and don’t exceed the LTV threshold with a second HELOC, it’s a possibility.
If all your choices are exhausted, an unsecured loan, such as a personal loan, or a credit card may be your only alternative to tapping equity. You’ll pay higher interest rates with these products, but they’ll allow you to finish a home renovation.