Home improvement financing

Of the many ways available to fund home improvements, tapping home equity is a popular option. Borrowers cite the benefits of lower interest rates associated with secured debt and the tax deductibility of loan interest. Lenders favor home equity loans as they carry lower risk.

Home equity is the difference between the value of your property and remaining mortgage debt. It is a valuable asset that can be used to upgrade to another home or used in retirement years. Tapping into equity not only depletes it but you also run the risk of losing your home in the event of default. As such, this resource should be used only when a return is certain.

If you are planning to use your home equity to fund a home-improvement project, you can do so with a cash-out refinancing or home equity loan.

Refinancing refers to a process of replacing an existing mortgage with a new one, usually on more favorable terms. In a “cash-out” refinancing, the replacement mortgage exceeds the value of the currently outstanding mortgage balance. Once the existing mortgage is settled, the borrower can “cash-out” the difference to meet the cost of home improvements. Refinancing involves closing costs. Therefore, the borrower has to compare the benefits by way of better loan terms and value addition to the home against the costs involved in arranging and servicing a bigger loan.

A home equity loan can be a fixed loan or a line of credit with a set limit that can be drawn down as and when required. It is normally a second mortgage over the home. Provided the primary mortgage holder has no objection to the taking out of a second mortgage, this option allows the home-owner to get funding for a specific project without altering the terms of the first mortgage. A term on a home equity loan is usually around 15-20 years although shorter or longer terms are possible. Interest rates are higher than for a first mortgage. A Home Equity Line of Credit (HELOC) has a variable interest rate that is linked to the prime rate.