Budgeting for Your Home Remodel
May 13, 2016
How to Budget For Your Home Remodeling Project
There are many reasons that people decide to take on a home remodeling project-
Expanding families, increasing energy efficiancy, or even just to change things up; a home remodeling project is something that can benefit you and your family in many ways. Many homeowners don't know where to begin in the process of budgeting in order to make a home remodeling project plausible. Often times, homeowners end up either in a debt they can't afford due to less-than-stellar lending practices from individuals, or they feel as though they can never afford a home remodeling project. This article aims to give out some good information that can act as a launching pad to those people interested in taking the next steps toward making a remodeling project a reality. Of course, you should always consult with financial professionals and make as informed a decision regarding your finances as possible.
Step 1. Deciding what you want
We all have those moments while living in our homes, in which we walk past a room and think "I really want to change ____ about that room". One of the first steps any home owner should take is deciding on what, exactly, is a realistic project for them. You will need to have as clear an idea of your project goals as you can before talking to any contractors. The more precise your idea, the more accurate the subsequent estimate will be. Make a list of all of the rennovations you would do if you had a magic wand you could wave over your house. Then, re-organize that list by priority. Which rennovations are the most important to you?
If you're looking to resell your home, then talk to a realtor and discuss which projects will give you the best return on your investment and therefore add to your resale value. They know what aspects of a home sell the best, and they are more than willing to help you get the most you can get out of selling your house.
If you are looking to stay where you are, then try to think about what rooms you use the most, or which rooms need the most attention. Narrow your list down to three options, and spend time trying to detail as much as possible the specific fixes that would be needed for each project. Once that is done, you're ready to take the next step!
Step 2. Estimates
This is the part of your home remodeling project on which you should spend the most time. It is important to shop around in order to avoid paying too much for your project. Make a list of ten contractors you may be interested in working with. Start off with a simple phone call, get a ballpark estimate, and narrow down your choices to the top 3 companies that you are considering. Then it is time to get into some real research.
An honest contractor will be more than happy to show you references, help you get into contact with previous clients to ask about their experiences, and will do anything else to prove their credentials. Make sure you ask tro see licenses, and that you verify those licences with your local governing agencies.
Meet with your potential contractors face to face. One of the most important aspects of a successful home remodeling project is having a rapport and trust in your contractor. You will be seeing a LOT of that person, so making sure that there aren't going to be conflicts due to personality differences is more important than you would think.
This is the time you will want to get accurate quotes. Go over your project in detail, and get as close an estimate as you can. Let each company know that you are speaking with the other two and find out which company will give you the best price, and the best quality work. Don't automatically go with the cheapest! Quality is key!
Step 3. Acquiring The Funds
When planning on a home remodeling project, especially a major one, you should estimate around $1-200 per square foot. A good practice for homeowners is to add 20-30% on top of the estimate they have been given by a contractor to account for errors, or unexpectedx expenses. Realistically, your total monthly repayment amount should never exceed 25% of your monthly take home pay.
Generally speaking, most people will not have the money on hand to cover the entire project. In those cases, it is necessary to look into financing. Most homeowners go with one of three main options for financing:
- Cash Out Refinance
- Home Equity Loan
- Home Equity Line of Credit or (HELOC)
1. Cash Out Refinance-
We would not recommend this type of financing, but it is a very valid, very viable option that is chosen by many homeowners across the country. A cash out refinance is a replacement of your first mortgage. The interest rates on a cash-out refinancing are usually, but not always, lower than the interest rate on a home equity loan. You pay closing costs when you refinance your mortgage.
2. Home Equity Loan-
A home equity loan is a loan in which you borrow against the appraised value of your home. This type of loan usually comes in a lump sum payment of a total amount with an interest rate which is either fixed or variable, depending on your loan. The loan is for a fixed amount which you are expected to pay back in monthly payments just like your mortgage. If you do not make these payments, it is possible for the lender to foreclose on your home, so it is important to truly understand the terms of your loan.
Equity is the difference between how much the home is worth and how much you owe on the mortgage .
3. HELOC (Home equity line of credit)
A HELOC works much like a credit card. Unlike a home equity loan, the amount of a HELOC varies. You borrow as little or as much as you need (up to a cap set by the lender), over a period of time. This means no lump sum payment is issued. In this situation, you but your home up as collateral, and the lender sends you either a check book or a card which you can use to draw from when you need to do so. The total potential loan amount is usually 70-50% of your home's appraised value.
The advantage to this type of loan over a credit card loan is that often times, the interest rate for a HELOC is much lower than what you would get with a credit card, and the interest payments are usually tax deductable; and you are often given a much, much higher limit on spending than you would be given with a credit card loan.
Additionally, the loan is over a set period of time, usually 10 years draw period, and 15 years repayment. Some loans require full repayment at the end of the drawing period, and in some cases you may be able to refinance your loan, although it is best to pay back your loan as quickly as possible to avoid paying more in interest.
There are a few drawbacks to this type of loan- so homeowners must be very careful! A HELOC is relatively easy to acquire, and if you are not keeping track of your spending, it is easy to spend well above your means of repayment. And, there are genrally fees associated with setting up this type of credit.
Want to know what a loan like this would look like in terms of repayment. Use this awesome tool to calculate what your burden would be for borrowing through a HELOC:
You will also want to shop around to find the best deal on a HELOC if you choose to do so. Use this worksheet when speaking to potential lenders because you need to know more than just what your monthly payments, interest, and principal may be!
Bad Lending Practices
Like it or not, there are many people and institutions which will take advantage of the unassuming homeowner looking to borrow money. Here are some major red flags to look out for when deciding on a lender. Some of these practices are against the law, some of them are just shady, so make sure to be informed and never hesitate to ask questions.
1. Insurance Packing
This is when a lender adds a lot of insurance on top of your loan amount which you don't need in order to secure a loan through legitimate means. Although lenders may require that you keep home owners insurance on your home during the loan, make sure to watch out for excessive insurance, or multiple types of insurance,
2. Loan Flipping
This is when a lender encourages you to refinance your loan, and to do so often, and often for a higher amount than when you initially got the loan. You will end up spending thousands in unnecissary fees, closing costs, interest points and it can be damaging to your credit. Although not illegal, it is generally frowned upon as an under-handed lending practice.
3. Equity Stripping
A lender should look at your ability to repay the loan before issuing it. When a lender only takes intoaccount the equity of the home and disregards your ability to pay back the loan, this is called equity stripping. Many people get into trouble with this situation because they are seeking to get as much as they can on their loan. It is much better to borrow as little as you need, because remember, if you don't pay, you can lose your house.
4. Non-traditional Products
Beware of lenders who offer you loans that have a monthly payment that sounds too good to be true. It probably is. Often times these types of loans have an incredibly low monthly payment, but then have a HUGE lump-sum balloon payment at the end which many people cant afford.
Some lenders will try to set you up with a low monthly payment, but the payment isnt enough to cover the principal and the interest payment. You end up at the end of your loan term with a balance still remaining, and often have to get another loan. This lending practice is just another form of loan flipping.
5. Rushed by contractor
A contractor offers you a loan through a personal lender, and rushes you through the process, often starting work immediately and then bringing blank papers, or urging you to sign quickly, and guilting you into doing so because they have already started the work. They can threaten to leave the work unfinished if you dont pay, and use this type of bullying to get you to sign up for loans with a huge interest amounts. The contractors in these situations usually get a payment from the lender as a finders fee, and since they are already paid, they pay little attention to the quality of the work they do on your home.
It is possible to find a great lender and make a home remodeling project a reality. It takes a lot of homework, and a decent amount of time doing research, but in the end, you can end up with the home of your dreams for less than you coul have imagined! Whichever you choose, make sure to be an informed consumer, shop around, and ask a million questions!