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Financing a major home renovation

Q. My husband and I are planning to build an addition on our home. Which would you recommend, a home equity loan or a construction loan, and why?

Ideally, you would combine the construction loan with your existing mortgage into a new first mortgage. You'd only look at a second mortgage (home equity loan) if the appraisal weren't high enough to justify the new, larger first mortgage.

The real key to successfully financing the addition is in how the addition increases the appraised value of your home. Paybackestimator provides both regional and national averages for different remodeling projects.

Let's just say for discussion purposes that you'll realize 80 cents on the dollar for your addition in a best-case scenario and 60 cents on the dollar in a worst-case scenario.

 
Best Case
Worst Case
Current appraised value
$365,000
$365,000
Loan balance
$280,000
$280,000
Construction loan
$200,000
$200,000
Payback percentage
80%
60%
Post construction appraisal
$525,000
$485,000
Total loans
$480,000
$480,000
Loan-to-value
91%
99%

The higher the loan-to-value, the harder it will be to roll the construction loan into a new first mortgage. That's when you would want to consider a home equity loan vs. refinancing.

See Also
FAQ: How construction loans work
FAQ: Rate locks
FAQ: Converting a construction loan
FAQ: Construction-to-permanent loans
FAQ: Interest paid on a construction loan
FAQ: Financing the building of a new home

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Home Equity
Compare today's rates
NATIONAL OVERNIGHT AVERAGES
$30K HELOC 4.36%
$50K HELOC 4.06%
$30K Home equity loan 5.08%
Rates may include points



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