Money Matters

THE MOST IMPORTANT DECISION YOU MAKE WHEN PLANNING A HOME RENOVATION WON’T BE WHAT KIND OF COUNTERTOPS TO CHOOSE OR WHAT COLOR TO PAINT THE FAMILY ROOM—IT WILL BE HOW TO FINANCE THE PROJECT.

Do you tap into your savings, borrow from your 401(k) or take out a loan? Does it even make sense to spend money upgrading your home when values have been declining?

Actually, the answer is: It depends on your circumstances.

For instance, if you’re already upside-down on your mortgage—that is, you owe more than your home is currently worth—then it may not make sense to remodel, says Joe Nunziata, CEO at the Orlando">Orlando-based mortgage brokerage firm FBC Mortgage LLC.

“But if you own a home with equity and you want to improve its value, go ahead,” Nunziata says.“Still, you should explore all of your financing options.”

And if you’re in the market to buy a home, he adds, “there are some great deals out there—you can buy a home that needs a little TLC and it’ll be a great investment.”

In fact, now may be the best time to buy if you don’t mind renovating, experts say. Mortgage rates are low and inventory is high.

“There are plenty of distressed properties that need a lot of work on the market right now,” says Justin J. LaManna, a real estate broker and owner of Homevest Realty in Orlando">Orlando. “But you have to do your due diligence to find the right home.”

Don’t make a decision until you have a true picture of the home’s condition and accurate estimates from reputable contractors on what repair and renovation costs will be.

“Buying a fixer-upper has hidden dangers,” says Bob Carrigan, sales manager at Wells Fargo Home Mortgage. “But people now are buying because they’re getting such good deals.”

Carrigan advises would-be buyers to investigate programs that combine the purchase price and the cost of remodeling into one loan, such as the Wells Fargo Purchase & Renovate Program. The amount the homeowner can borrow is based on the increased value of the home after improvements are made—and the interest on the cost of the improvements could be tax-deductible.

“You need a mortgage lender who knows the mortgage business and understands people,” says Robert “Topper” Peacock Jr., a real estate attorney with Zimmerman, Kiser & Sutcliffe in Orlando">Orlando says.

Also, look for a remodeler who’s a member of your local home builders association, says Andy Brown at Fidelity Funding Mortgage in Altamonte Springs. “The remodelers who are members tend to know what they’re doing.” In Orlando">Orlando, that would be the Home Builders Association of Metro Orlando">Orlando, which has an active Remodelers Council.

Getting a loan, of course, is not as easy as it once was. Guidelines are tougher and every loan has to be audited before it closes. Therefore, says Brown, expect the loan process to take longer than it did a few years ago.

Before you close on your loan, you’ll need to work with your remodeler to create a draw schedule. A construction draw is an agreement between the homeowner, the builder and the lender that clarifies when and how payments will be made during the remodeling project.

“Each bank has a different draw schedule,” Nunziata says, “but after each stage of construction, the lender inspects the work and releases funds for the next stage. Sometimes they make the check payable to the builder but more commonly to the builder and homeowner jointly.”

Most experts say borrowing from your retirement savings or using credit cards isn’t the best way to go when financing a remodeling project—especially when loan rates are so low. Here are some of the most popular financing options:

> Home equity loan/second mortgage. A home-equity loan can get you a lump sum of cash at a fixed interest rate with a payback period of, say, five years. This loan—also known as a second mortgage—is based on the amount of equity in your home.

> Cash-out refinancing. If you have enough home equity and/or you have a small project, you also can “cash out,” or take out a new mortgage that will pay off your existing mortgage as well as fund your remodeling project. Refinancing your mortgage could be a smart move if interest rates are lower today than when you bought your home.

“The easiest and best way to finance a remodeling project is a cash-out refinance, assuming you have equity in your property,” Nunziata says. However, some homeowners—especially those who purchased a year or two ago at the peak of the boom—have found to their chagrin that the equity they thought they had has diminished or vanished.

However, also remember that while the decline in home values seems drastic because it has occurred over a short period of time, the bigger picture isn’t nearly as dire. If you’ve lived in your home eight or ten years, it’s likely worth more—perhaps considerably more—than you paid for it despite recent price drops.

> Home equity line of credit. A home equity line of credit is a form of revolving credit that uses your home as collateral. You can use some or all of the money available whenever you need it.
“You pull out what you need when you need it,” Carrigan says. “The beauty of that is you don’t have to pay interest on the money you’re not using.”

The credit line often is set at about 80 percent of the home’s appraised value minus the balance of the mortgage. But the amount of credit available to you will also depend on your credit history and your ability to repay the money.

> Cash. “If you’ve got cash, you feel good about improving the value of your home and you’re afraid of the stock market, cash is an option,” Nunziata says.

Compare the interest rate on a loan you’d get if you choose to finance your renovation to the in-terest you’d be earning if you invested the money instead. Which makes the most sense?

“I would say, in most cases, save your cash,” Carrigan says. “You might need it. Besides, rates are still low. It’s a good time to borrow.”

One more thing to consider: Interest payments on a home improvement loan may be tax-deductible.

> Federal Housing Administration loans. FHA offers the Section 203(k) program, which is for more extensive rehabilitation projects, and the 203(k) Streamline Limited Repair program, which is for less extensive repairs.

The Streamline program allows you to finance an additional $35,000 into your mortgage to improve your home before moving in.

“For a house that’s now upside-down, but a remodel would improve its value, you can get plans and specs drawn up and get a construction modification loan,” Nunziata says. “The FHA 203(k) is a rehab loan. It may not be the best choice for everybody. There are certain items that it’s required that the borrower get done. For example, maybe they require you to put on a new roof even if you don’t feel like you need a roof yet.”

To take advantage of these programs, the property value must remain within the FHA mortgage limit for the area once the rehabilitation or repairs have been completed and you must use an FHA-approved lending institution. Many—but not all—mortgage lenders are approved to make loans through this program.

> U.S. Department of Agriculture Rural Housing loans. The rural development loan program, which is guaranteed by the USDA, allows you to buy an owner-occupied home with 100 percent financing on a market-rate, 30-year fixed mortgage with no mortgage insurance requirements.
The home must be in an eligible area—no highly populated cities—and your income can’t exceed guidelines set for the area. But closing costs may be rolled in if the appraised value exceeds the contract amount.

The bottom line: If remodeling does make sense for you, find a lender and a contractor you can trust, says Peacock “Don’t make the mistake of trusting a stranger who places a flyer on your door or an ad on the Internet.”