How to Finance a Home Addition
Deciding when and how to finance a home addition can be complex — yet, depending on your situation and goals, there are several good options.
One of the realities of home ownership is that even though you’re “saving money” on rent by building equity in your home, you often have to spend money to maintain or improve your home. If you want to add a new bedroom or bath, expand an existing kitchen, add a deck or porch, or otherwise improve your living space, you may want to explore your options for how to finance a home addition.
Here are a few tips for the most efficient and economical ways to finance a home addition — along with some possible advantages and drawbacks of each:
Refinance Your Mortgage to Free up Funds for Home Additions
If you have already lived in your home for a few years, and you may qualify for a lower interest rate than when you bought the home, you may want to consider refinancing your mortgage. This can either give you a “cash out” option, where you can get a lump sum of cash from your home equity that can be spent on your home addition, or you can free up some extra money each month by having a lower monthly mortgage payment from your refinancing.
ADVANTAGES: Reduce your monthly mortgage payment and use the extra cash each month to pay bills.
DRAWBACKS: Refinancing your mortgage typically means that you start over from year one of a new 30-year mortgage. This means that it will take you many years to pay off the debt from your home addition. For example, with typical mortgage terms, you might end up paying back the cost of the home addition over 30 years. (Unless you set up your refinanced mortgage to have a shorter repayment period, such as 25 years or 15 years, or set up accelerated mortgage payments.)
Use a Home Equity Loan or Line of Credit
Instead of refinancing your mortgage, this option lets you borrow against the value of your built-up home equity. Rather than paying off your home renovation debt over 30 years, a home equity loan or line of credit gives you a separate monthly bill to cover the costs of your home addition.
Rather than paying off your home renovation debt over 30 years, a home equity loan or line of credit gives you an extra bill to pay each month, separate from your current mortgage payment.
A home equity loan has a fixed amount and a fixed repayment term — such as 10 years or 20 years. A home equity line of credit (or HELOC) works more like a credit card – typically with a 10 year draw period followed by a 20 year re-payment period. With these kinds of loans, borrowers are often required to make interest and principal payments during the re-payment period and there is often a variable interest rate.
If you have a lower first mortgage balance, you can also use a home equity loan to refinance your first mortgage rather than taking a second loan. This can be accomplished by taking a loan greater than your first mortgage balance, paying off your first mortgage, and taking the difference in cash for your home improvement needs.
ADVANTAGES: No need to redo your mortgage payment schedule as you would with a refinance. Also, home equity loan/line of credit debt is typically low interest debt because it is secured by your home. Home equity loans may come with low or no fees. For example, Discover Home Equity Loans charge $0 applications fees, $0 origination fees, $0 appraisal fees, and $0 cash at closing. The home equity line of credit is a particularly flexible option because you can borrow as much or as little as you need (within a preapproved credit limit) and then pay it back on your own schedule.
DRAWBACKS: You will have an additional monthly debt payment to make — so be sure that you can handle the added debt as part of your monthly cash flow. Be careful not to borrow too much money from your home equity line of credit. Don’t treat your home equity like a piggy bank — you may consider asking for a lower borrowing limit than you qualify.
Strategically Use Credit Cards to Cover Home Addition Costs
Some home addition costs can be paid for with a credit card, just like any other household expense. If you need to buy new building materials or pay contractors for their work on your home, depending on the amounts involved, it might be easier to just put those bills on your credit card and pay off the debt along with your usual monthly expenses.
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ADVANTAGES: Using credit cards is simple and quick; there is no need to go through the process of applying for a home equity loan or mortgage refinancing. If you only need a few thousand dollars for your home repairs or renovation, you might consider putting that expense on your credit card — especially if you can earn credit card rewards points.
Home improvement retail stores may offer introductory 0% APRs if you apply for a new credit card through their store — so if you have to make some major purchases for a home addition, and you’re doing most of the business through a major retailer, look into your options for a new store credit card. Depending on the specific terms, and if you have a good enough credit score, you may qualify to pay off the whole amount within 12 months and pay no interest.
DRAWBACKS: Credit card interest rates are typically higher than home equity loans or mortgage debt, since it is unsecured debt. Also, be careful when signing up for 0%-interest offers — if you do not pay off the full amount within the introductory period, in some cases you can owe interest on the full original balance on the card. Promotional 0% interest credit cards can be a great deal but, to avoid interest and fees, you need to read the fine print carefully and make sure to pay off the full balance within the specified 0% time period.
Bottom Line on Financing a Home Addition
Improving your home is an investment of time, money and energy (both physical and emotional) — so make sure you feel comfortable with whatever option you pursue to finance a home addition. There are often several good ways to use the value of your home to get financing — whether by refinancing a mortgage or getting a home equity loan or line of credit.
If you don’t qualify for those options or don’t want to go through the time-consuming process of applying for a refinance or home equity loan, consider paying for your home renovation with a credit card — especially if you get rewards points or can qualify for a special low-interest introductory offer on a new credit card.