MyFinancialPrograms

This community member experience finding the best way for their circumstance to do their renovations is past of our series on funding home renovations and repairs.

Homeowner Profile:

Name: Mark and Lisa R.

Location: Austin area, Texas

Home: 3-bedroom, single-family home

Project: Kitchen and bathroom renovation

Family income: $98,000

Funding: Home Equity Line of Credit (HELOC)

Background:

Mark and Lisa R., a middle-income couple living in Austin, Texas, had been in their home for 12 years. While their home was structurally sound, they felt the kitchen and bathrooms were outdated and lacked the modern, open layout they envisioned. As their two children grew older, they also needed more functional spaces for family meals and entertaining guests. They estimated the project would cost about $60,000, but didn’t want to deplete their savings to cover it.

After researching different financing options, the Mark and Lisa decided to leverage the equity they had built in their home over the years and opted for a Home Equity Line of Credit (HELOC) to fund the renovations.

Researching Financing Options

Before committing to a HELOC, Mark and Lisa explored several home improvement loan options to find the best fit for their financial situation and renovation needs. They wanted to minimize interest costs, maintain flexibility, and avoid high monthly payments. Here’s an overview of the options they considered:

1- Personal Loan:

Pros:

– No Collateral Required: Mark and Lisa wouldn’t need to use their home as collateral with a personal loan, reducing the risk of losing their home if they couldn’t make payments.

– Fixed Payments: Personal loans usually have fixed payments, making it easier to budget for monthly costs.

Cons:

– Higher Interest Rates: The couple found that personal loans carried much higher interest rates compared to secured options like a HELOC, often ranging between 8% and 15%. For a $60,000 loan, this would significantly increase the total cost of the renovation.

– Shorter Repayment Terms: Personal loans typically come with shorter repayment terms (3 to 7 years), which meant their monthly payments would be much higher—something they wanted to avoid while saving for their children’s college tuition.

Why They Didn’t Choose It: The high interest rates and shorter repayment period were the main drawbacks. For a project as large as $60,000, Mark and Lisa realized a personal loan would be too costly and could strain their monthly budget.

2- Cash-Out Refinance:

Pros:

– Lower Interest Rate: A cash-out refinance would allow Mark and Lisa to refinance their existing mortgage at a potentially lower interest rate, rolling the renovation costs into their new mortgage.

– Longer Repayment Term: By refinancing their mortgage, they would have up to 30 years to pay off the renovation costs, spreading out their payments over a longer period and keeping monthly payments manageable.

Cons:

– Closing Costs: Cash-out refinancing comes with closing costs, which can be substantial (often between 2% and 5% of the total loan amount). For Mark and Lisa, this added several thousand dollars to the upfront costs, which they were hesitant to pay.

– Long-Term Debt: While the monthly payments would be lower, Mark and Lisa realized that they would be paying off the renovation for decades—far longer than they anticipated needing for their home upgrades. Extending the debt on their mortgage didn’t align with their long-term financial goals.

Why They Didn’t Choose It: Although the interest rate was appealing, the prospect of paying closing costs and extending their mortgage over 30 years made a cash-out refinance less attractive. They preferred a solution that offered more flexibility and didn’t add to their long-term debt burden.

3- Home Improvement Loan:

Pros:

– Purpose-Built for Renovations: Home improvement loans are designed specifically for renovations and typically offer fixed interest rates and terms.

– No Need to Refinance: This option would keep their current mortgage intact, without the need for refinancing or paying closing costs.

Cons:

– Higher Interest Rates than HELOCs: Even though home improvement loans are secured, they still came with higher interest rates compared to HELOCs. Mark and Lisa found rates in the 7% to 12% range, which was higher than what was available with a HELOC.

– Limited Flexibility: Home improvement loans offer a lump sum upfront, which meant that Mark and Lisa would be borrowing the full $60,000 even if the renovation didn’t require all of that money immediately. This wasn’t ideal for their phased renovation plan, where costs would be spread out over several months.

Why They Didn’t Choose It: The lack of flexibility and higher interest rate made this option less appealing. Mark and Lisa preferred the revolving nature of a HELOC, where they could borrow only what they needed when they needed it.

4- Home Equity Line of Credit (HELOC):

Pros:

– Lower Interest Rate: HELOCs typically offer interest rates lower than personal loans and home improvement loans. Mark and Lisa found that they could secure a rate as low as 6.4%, which was highly competitive.

– Revolving Credit: With a HELOC, they would only borrow what they needed as the renovation progressed, making it easier to manage cash flow. They would also have access to additional funds for future projects without needing to reapply for a loan.

– Flexible Repayment: HELOCs offer a draw period (typically 10 years), during which borrowers can make interest-only payments, giving Mark and Lisa flexibility if unexpected expenses arose.

Cons:

– Variable Interest Rate: The downside of the HELOC was the variable interest rate. While it started at 6.4%, it could increase over time, potentially raising their monthly payments if interest rates went up.

– Home as Collateral: The HELOC was secured by their home, meaning failure to make payments could result in losing their property. However, Mark and Lisa felt confident in their ability to make payments and were comfortable with the risk.

Why They Chose It: Ultimately, Mark and Lisa selected the HELOC due to its lower interest rate and flexibility. They liked the idea of borrowing as needed, rather than taking out a large lump sum. The HELOC’s interest-only payments during the draw period also provided flexibility in case of any unforeseen costs. While they were aware of the risks associated with a variable interest rate, they decided to mitigate that risk by making extra payments when possible and reducing the principal balance quickly.

Decision for an HELOC:

After thoroughly evaluating these options, Mark and Lisa were confident that the HELOC offered the best combination of flexibility, low cost, and manageable monthly payments. They applied for the HELOC with their mortgage lender and received approval for a $100,000 credit line at a 6.4% interest rate. This decision allowed them to proceed with their kitchen and bathroom renovations while keeping their financial future secure.

Summary of Financing Options They Explored:

– Personal Loan: Higher interest rates, shorter terms, no collateral.

– Cash-Out Refinance: Lower interest, closing costs, long-term debt extension.

– Home Improvement Loan: Fixed terms, higher rates than HELOC, lump-sum payout.

– HELOC (Chosen): Low interest, revolving credit, variable rates, home as collateral.

Mark and Lisa’s choice of the HELOC provided the right balance of affordability and flexibility, making it the ideal solution for their home improvement needs.

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