One of the joys of owning your home is that you have the freedom to change it. Maybe you want to knock down a wall in your kitchen or add windows so you can admire your backyard over breakfast. If you’re feeling really adventurous, you might add a second story and create the game room you’ve always dreamed of. Whatever your dream may be, you’ll need to finance a home addition to make it happen.
According to Home Advisor, the average cost of home addition in 2017 is $41,647. That’s a large chunk of change. How can you finance this expense? There are several routes you can take to get a home improvement loan.
Finance a Home Addition: Personal Loan
If you have a healthy credit score, consider financing your addition with an unsecured personal loan. The application process is usually easy, and you won’t have to put collateral or equity on the line. Online lenders like Lightstream and SoFi make this route more accessible than ever. However, since your credit score will determine the attractiveness of your terms, this may not be the best option for those with middling or poor credit.
If you’d like to find out what you qualify for, you can do so with SuperMoney’s loan prequalification tool. Just answer a few questions and you’ll receive personalized offers from a list of lenders, without any risk to your credit score.
Different personal loans come with different rates, fees and requirements, so check out what the best personal loans are to ensure that you choose the best option for you.
Finance a Home Addition: Tap into your equity
If you want to tap into the equity you have in your home, you have three options.
Option 1: Home equity loans and lines of credit
A home equity loan is a loan secured by your home equity. With this option, you’ll receive the money you need as a lump sum, and it will generally come with a fixed interest rate. Because the loan is secured by your home equity, you can get lower interest rates. But if you fail to make your payments, your home is on the line. And home equity loans often come with additional expenses, such as closing costs and maintenance fees.
A HELOC is a line of credit secured by your home equity. With a HELOC, you’ll receive access to a line of credit secured by your home equity. HELOC lenders generally charge variable interest rates, but you can tap into the credit (and pay it back) repeatedly as needed.
For both home equity loans and HELOCs, borrowers can usually borrow up to 80-90% of the value of their home.
Sandra Hamberg is a homeowner who recently finished a few home additions, adding a game room and remodeling her kitchen with new appliances and cabinets. She says, “We chose a home equity loan for our financing due to the low-interest rate and the hope to be able to write off the interest on our taxes.”
When you’re borrowing against your home’s equity, lenders will have guidelines in place for how much they’re willing to lend. For example, most will loan you 85% of the equity you have in your home. Furthermore, lenders will vary in how much they will charge you to borrow the money and how long you have to repay it.
Therefore, you’ll want to shop around to review and compare what different lenders will offer you and to find the best fit for your situation.
Option 2: Cash-out refinance
Another option is a cash-out refinance. With this route, you’ll take out a new, larger loan, through which you’ll pay off both your current mortgage and your new addition. Ideally, seek out a new loan with more desirable terms than your original mortgage loan.
What are the advantages of the cash-out refinance? It lets you manage all your payments in a single mortgage, and it can potentially offer lower interest than home equity loans. However, this option comes with risk. The loan will be secured by your house, so if you fail to make your payments, you could lose your home. You will also have to pay for processing fees.
Option 3: New equity financing model
Lastly, a new type of equity financing has emerged. Equity financing companies like Patch Homes offer home equity financing without any interest or monthly payments. All they ask is an up-front fee, and a percentage of the difference in the value of your home after an agreed upon the span of time.
Let’s look at an example. Let’s say your home was worth $500,000 before the addition, and you agreed to pay 25% of the home’s appreciation or depreciation after 10 years. After 10 years, if your home was worth $600,000, you would owe $75,000 — the original sum $50,000 plus 25% of the $100,000 increase.
The advantages of this option are obvious. You’ll get the money you need to remodel your home, without having to worry about appreciating debt or keeping up with monthly payments. However, you will have to pay an upfront fee. And depending on how much the value of your home changes, you could end up paying a good deal more than you would have with a standard loan.
Finance a Home Addition: With Credit Cards
Credit cards are another type of unsecured financing you can consider. As with personal loans, your credit score will determine your approval.
Generally, credit cards feature higher interest rates than personal loans, making them a less desirable option. However, some credit cards offer interest-free introductory periods — usually 18 to 21 months. If you felt confident that you could pay off your balance before the period was up, you could get the money you needed without paying a cent of interest. What’s the catch? If you fail to pay off your debt before the introductory period ends, your interest will rocket up.
Another strategy is to combine financing methods. For example, you could use your interest-free credit card through the end of the introductory period, and then use a personal loan to pay off your remaining balance. You’ll avoid the credit cards increased interest rates, and will have a much smaller balance in your loan to pay interest on.
However, this option depends on your ability to qualify for a card with a high enough credit limit to finance your project. And if you max out your credit card, it will hurt your credit utilization ratio. Until you pay off 70% of the amount borrowed, this will also hurt your credit score.
Government Programs to Finance a Home Addition
When the government insures loans, it reduces the risk for lenders. This makes it more likely that they will lend to you. If you have bad credit and are struggling to get approved through other avenues, check out these programs.
203(k) insured loans
203(k) insured loans are similar in structure to cash-out refinance loans. They aim to simplify the process of making repairs or renovations to a home. The U.S. Dept. of Housing and Urban Development (HUD) program insures single-close long-term mortgages with either fixed or variable interest rates. Only FHA-approved lenders offer these loans.
Title 1 loans
Title 1 loans are similar to personal loans. They are home and property improvement loans provided by approved Title 1 Lenders and insured by HUD.
Bring Your Home Addition Ideas to Life
Making an addition to your home is a big project that will take time, patience, and capital. But in the end, you can enjoy the renovations that made your home exactly as you want it to be.
Your first step is to research your options and find out what you qualify for. Need help? Check out SuperMoney’s loan engine to get personalized offers in a matter of minutes.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.