Summer is approaching and homeowners can consider home improvement and repair projects during the warmer months. But with interest rates starting to rise, consumers should carefully consider their financing options.
The pickup in house prices means more people have equity in their homes that they can tap into for projects like adding a bathroom or upgrading a kitchen. However, as interest rates rise, homeowners may consider tapping into that equity for a renovation.
“I think the rate landscape is a factor at this point,” said Greg McBride, chief financial analyst at Bankrate.com.
Consumers still have an appetite for home renovations, research suggests. Renovation and repairs are expected to remain strong this year, before slowing down in early 2018, according to a report in april of the Harvard Joint Center for Housing Studies Future Reshaping Program.
Mike Kinane, general manager of home equity products at TD Bank, said he expected “consumers to borrow against their homes” for home improvement projects
How are you going to pay it?
If you have the money, it’s wise to consider using it, as interest rates paid on savings are still quite low, said Robert Schmansky, founder of Clear Financial Advisors outside of Detroit. . If you have to finance the work, then a home equity loan or line of credit “isn’t the end of the world,” he said, although he suggested paying it off as quickly as possible.
With the trend of rising interest rates, refinancing an existing mortgage to withdraw money for a renovation becomes less attractive. The average rate on a 30-year fixed-rate mortgage was 4.03% last week, according to Freddie Mac, down from 3.66% a year ago.
Home equity lines of credit, which work like a credit card rather than a traditional term loan, have been one of the most popular ways to finance home improvement. Lines of credit, or Helocs, are more complex to manage than a traditional second mortgage, however, and come with variable interest rates, usually tied to the prime rate. This means that the monthly payments will increase – perhaps more than some homeowners want – if the interest rate on the loans increases.
Credit lines typically have a 10-year “drawdown” period, during which borrowers use available funds as needed and make interest-only payments. After the drawdown period, the lines are typically converted to regular installment loans, with monthly payments of interest and principal required over 10 to 20 years.
The average rate for a home equity line of credit is 5.45%, McBride said, although some lenders offer initial “teaser” rates as low as 2.99% for an introductory period, typically. six months.
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Before the financial crisis, when home values soared, borrowers used the lines to finance everything from vacations to new cars. But since the recession, borrowers have been using lines more responsibly, to finance specific improvements to their homes or to pay for school fees, Kinane said.
“Most of it is under renovation,” he said.
The average drawdown – the amount of credit line used – is around $ 50,000 nationwide, Kinane said.
Home equity loans – a traditional second mortgage, usually made at a fixed interest rate – may be more acceptable than lines of credit as rates rise.
Mr Kinane said he had seen a “very slight increase” in applications for home equity loans, rather than lines of credit, as borrowers react to the news of rising interest rates.
But home equity loans can be harder to come by, McBride said. Many large banks have stopped doing them, preferring to offer lines of credit, which reduces the risk to the lender of rising rates. However, borrowers looking for home equity loans are likely to find rates comparable to the average rate on a line of credit. “You have to go around,” he said.
The choice ultimately depends on the consumer’s risk tolerance. “If they don’t like the possibility that the rate might change,” Kinane said, “then the loan product is probably a safer bet.”
There is another way to manage the risk of rising rates: Many lenders offer the option of converting the amount you have already withdrawn from a line of credit into a fixed rate loan to lock in a rate.
Here are some questions and answers about home equity financing:
Should I use a home equity line of credit immediately?
Some lenders require a “minimum drawdown” when you close your line of credit, McBride said. So make sure you know these requirements and determine if they fit into your project schedule. If you have to borrow $ 10,000 up front, but your contractor can’t schedule you for several more months, you’ll end up paying interest unnecessarily.
Is there a downside to using a fixed rate home loan for a renovation?
Loans are made in a lump sum. You can’t borrow more if your project is over budget. Revolving credit lines are more flexible. You borrow as you need the money. So they may make more sense for projects that are done in stages over a longer period of time, McBride said.
Can I deduct the interest I pay on a mortgage or line of credit?
In general, yes. But check with your tax advisor.