If you’re hoping to remodel your home anytime soon, you may be surprised to discover your financing options have changed from those available in years past. While it is still absolutely possible to finance and conduct a large remodeling project, some of the stipulations you have to meet have recently been altered. Find out why the scene on remodels is changing and learn your best options for financing your remodel.

Why the economy is affecting remodels

The slump in the housing market and accompanying economic decline are having a major effect on remodel financing. This is because lenders are much more hesitant to award money to borrowers hoping to remodel their homes. Don’t worry though – there are still multiple ways you can land financing for a remodel.

Essentially, the problem boils down to most lenders tightening their standards for all borrowers. They cite declining home values and concerns over the nation’s subprime mortgage market as their rationale. Unfortunately, these new standards affect everybody, from the least creditworthy to those with excellent credit records.

The way it used to be

As recently as a couple years ago, individuals planning a remodel could borrow against the value of their homes – sometimes as much as 90% of their home equity. During this lending boom, home values were rising at 15% – 20% each year so lenders were willing to assume the risk.

Now that the real-estate market is largely flat (and in some areas, declining), lenders aren’t willing to take on that same risk.

Appraisals also play a part in home remodel financing

To add to the hesitancy lenders feel when it comes to financing major remodeling projects, the environment for appraisals is becoming tighter. Many lenders are requesting second appraisals on homes before even considering granting a loan. Some are going so far as to secong-guess the value of a home and the credit score of a borrower.

What the tighter market means for your remodeling project

As mentioned earlier, the tighter lending standards now make it harder to secure financing for major remodeling projects…but they don’t make it impossible.

In most cases, tighter lending means you should consider three things before pursuing a remodeling project:

1. Make sure the remodel is something that will really enhance your quality of living – don’t remodel in an attempt to boost your home’s value. In fact, few remodel projects recover their costs even when housing prices are rising. This means the best reason to conduct a remodel is to make your home more comfortable for you and your family.
2. Get your credit score in order. If you have bad credit, there’s little chance you’ll secure a decent loan for a remodel. Work to get your credit score in order by paying off old debts and by checking your credit report for potential errors.
3. Get an honest appraisal of your house. Don’t try to inflate the value of your house. Secure an honest appraisal from a reputable company so you’ll know how much equity you have to work with.

5 Best ways to pay for remodeling

If you intend to go through with a remodeling project in the current tight economy, be assured that there are still many loans available for creditworthy borrowers. This is especially true if you have substantial equity in your home. On top of that, loan rates remain at historical lows.

Here are your top five borrowing options for remodel projects:

1. Home equity loan. This is the best option is you have a one-time remodeling project. Home equity loans are secured by your home’s equity. Your interest rate and the amount you borrow are fixed at the time you sign for the loan. Most loans last from 5 – 30 years.
2. Home equity line of credit (HELOC). Pursue this option if you have several projects planned that will take a few years to complete. A HELOC allows you to borrow only what you need and then sets you up with payments once you start accumulating a balance. Your payments will be calculated based on a variable interest rate. All interest paid on HELOC loans is tax-deductible as long as your project is intended to build, buy, or improve either a principal residence or second home. You can keep this type of credit line open for up to ten years and closing costs are usually around $50.
3. Cash-out refinancing. This option is ideal if you have significant equity in your home and plan to pursue a large remodeling project. For example, say you have $100,000 worth of equity in a home that’s worth $250,000 (meaning you still owe $150,000). You can take out a new first mortgage for $200,000, pay off the $150,000 you owe, and use the remaining $50,000 for your remodel. This approach allows you a longer payback period (as much as 30 years) than a HELOC. The downside is that you could pay much more in closing costs.
4. Home-center project cards. Home improvement centers like Lowe’s and Home Depot both offer project cards for purchase through their stores. These cards carry a 0% interest rate for six months after your first purchase. The interest rate ranges between 8% and 18%. Neither store has a set maximum on these cards but both require a minimum first purchase of $1,000. This is an excellent option if you’re confident you can pay off your balance within six months.
5. 401(k) loan. If your employer allows you to borrow from your 401(k), look into the interest rate and payback period you’ll be assigned. This could be a viable way to finance a remodel – just remember you’ll have to pay back what you owe. In addition, know that until you’ve paid back the amount you’ve borrowed, you’ll be temporarily reducing your tax-deferred retirement savings.