Budgeting and Financing for Home Renovations
When you’re considering a remodeling project for your home, you must first establish a budget. How much can you afford? We’ll help you get started.
STEP 1: Take stock of your finances.
Gather all your bank and mortgage statements and other financial information. Consider your income, your current mortgage payment, any savings that you have available, and other payments or debts that you have right now. Consider a savings goal for the project: how much could you set aside to put towards the project?
STEP 2: Consider your assets.
Many people choose to take out a loan against the equity they already have in their home. This type of financing is relatively easy to get because the value of your home backs the loan. Lenders know that home improvement loans usually result in a higher value for the home, making it a safe investment for them.
Bear in mind that just because you can obtain a certain line of credit doesn’t mean you have to use all of it. Balance the need for the repairs or renovations with the value of retaining some equity.
Do you have any other assets that could be sold to raise some capital? Get creative!
STEP 3: Explore financing options.
Talk to the loan officer at your financial institution to see what your options are. In general, home equity loans are granted with a maximum loan-to-value ratio, or LTV of 80%. For example, say your home is valued at $200,000 and you have $100,000 of equity in your home. The bank would take 80% of the home’s value – $160,000 – and subtract the balance on your loan – $100,000. Using this loan-to-value ratio, you would be able to borrow up to $60,000.
Another factor your bank will look at is of course your credit. In addition to a good credit score, your lender will want to see a good debt-to-income ratio. Ideally, you should have less than 40% of your monthly income going to debt payments, including your prospective home equity loan.
The “Fixer Upper” Option
Another option is to purchase a home on the market and remodel it to fit your needs. A “fixer upper” doesn’t have to be a frightening proposition. It may be the opportunity you need to get your dream home!
If you want to buy a home and remodel it, consider the same steps above. You’ll still need a thorough understanding of your finances, including the equity in your current home and any savings you have toward a down payment, and to explore your mortgage options with your lender. You will have a total budget that will include the purchase price for the home and the cost for any repairs or remodeling.
Buying a home with the intention of remodeling it can be daunting, depending on the condition of the house. Hire a reputable home inspector to give the property a thorough analysis and identify any structural issues or repairs needed that may take away from your renovation budget.
Sticking to Your Budget
Going over budget can turn your dream home renovation into a nightmare. The best way to stay under budget is to establish a cushion as a contingency. Give your builder a budget number that is 30% under your absolute maximum. If emergencies crop up or something ends up costing more, you will have funds available to cover the difference.