Let’s assume you have explored your finances and have concluded that a bank loan is the proper path forward. Just what kind of bank loan should you pursue? The answer depends, to a large degree, on the amount of money you need to accomplish your goals.
While discussing this with a loan officer is the best source of current information, let’s talk about the two basic sources of dough: a home equity loan and a construction loan. The amount of money you can borrow with an equity loan is constrained by the value of your existing home, while significantly more dough is available with a construction loan, which is constrained by the value of your home after the remodel. Since the value of your home will increase because of the remodel, there is simply a higher value to borrow against.
Most people are aware of a home equity loan in which the borrower uses the equity in their home as collateral. A home equity loan creates a lien against the borrower’s house, and reduces actual home equity. An advantage of this form of loan is how simple, inexpensive and straight forward the process is:
- Your home is appraised by the bank in order to determine its current market value.
- The amount you already owe is subtracted from this appraised value, yielding your amount of equity. In other words, what amount of the home do you actually own (as opposed to that portion of the home the bank owns!)
- The bank will lend you an amount of money constrained by a specific maximum percentage of your existing equity
- Once the funds are given to you the bank is not involved with the remodeling project. Basically they don’t care what you do with the money so long as you pay it back! The only connection between the money borrowed, and your home, is that if you fail to pay it back your home is up for grabs! Not good.
If this equity loan does not get you sufficient funds to fuel your remodeling project, most people explore a construction loan. Steps 1 through 3 are basically the same as with an equity loan, except for the fact that the appraiser is asked to define the value of your home after the remodeling project is complete. Another difference is that the bank stays very involved with the project as it progresses. The bank will:
- Define how long you have to complete the project (usually 6 months).
- Send their own inspector to your home to make sure the amount of money your contractor requests has actually been spent on what they said they would do.
- Define if it’s alright for you, the homeowner, to perform any of the work.
Although the construction loan is more of an ordeal than an equity loan, the bottom line is that it provides more dough. It’s that simple.