||Ask Dr. Don
Best type of loan for remodeling
Dear Dr. Don,
My husband and I retired in 2000. We paid cash for our retirement
home and then spent another $25,000 remodeling our home. Unfortunately,
we need to put another $20,000 into the house to get it completed.
We want to borrow the money to finish the house. We only have a
fair credit history due to a previous failed business venture. What
type of loan should we go for?
With a 100-percent equity position in your home, getting a $20,000
mortgage loan, even with only a fair credit history, shouldn't be
Beyond looking at your credit, lenders are looking
at the money they have at risk when they extend you credit. You
may not get a lender's best rate, but you won't get its worst rate
either. See this
Bankrate feature to estimate how a lender would grade your credit.
Then go to Bankrate's Shop & Save channel to
your Equifax credit report and FICO credit score to see exactly
where you stand. It costs just $12.95.
You have three choices of loans: a home equity loan,
a home equity line of credit (HELOC) or a first mortgage. Which
loan is best depends on your retirement budget and your financial
A HELOC is revolving credit like a credit card. That
means you can get the loan, pay it down and then be able to borrow
the money again if you need to up until the loan's final maturity.
HELOCs are variable rate loans and have (at least initially) lower
interest rates than the other two loan choices because the lender
shifts the risk of rising interest rates to the borrower.
The home equity loan is set up like a fixed rate mortgage.
The interest rate doesn't change, monthly payments are fixed, and
principal is repaid (amortized) over the life of the loan. This
type of loan is good for project oriented financing like your home
improvements because you aren't tempted to re-borrow the money like
you might with a HELOC.
A first mortgage can have several advantages. You
can extend a first mortgage over a longer time period than a home
equity loan. While you'll pay more in interest expense by extending
the loan term, you'll also reduce the monthly payments. That can
be important when living on a fixed income.
Home equity loans and HELOCs have advertised rates
based on the assumption that a first mortgage on the property exists.
Without a first mortgage, your home equity loan is in effect a first
mortgage, but you may have problems determining whether the lender
has priced the loan to reflect your situation.
Your choices in interest rates are also more varied
with a first mortgage. You can choose an adjustable rate mortgage
(ARM), a fixed rate mortgage or something in between. The loan term
can vary from 10 years to 30 years, with 15-year and 30-year loans
being the most common choices. It may, however, be difficult to
find a first mortgage lender that is willing to loan you only $20,000
regardless of the loan term.
With no first mortgage outstanding, the closing costs
between a first mortgage and a home equity loan could be fairly
close. Home equity loans usually have lower closing costs because
the lender can use information available from the first mortgage
and that's not true in your situation.
If you've got a nest egg outside of the equity in
your home, then a home equity loan makes sense. If you don't have
a ready reserve to use in an emergency then I like the HELOC's revolving
credit terms. As you pay down the $20,000 you can tap your home's
equity for other reasons without having to get another loan.
A reverse mortgage could give you access to the money
without being tied to a regular payment schedule. You borrow against
the equity in your home, but the bill doesn't come due until you
sell the house or your estate sells the home. Both of you need to
be at least 62 to consider this alternative.
I don't think this is your best choice, I'd rather
see you hold that option in reserve, but you can learn more about
reverse mortgages in this
-- Posted: April 26, 2002