How to Pay for a Renovation If You Can't Afford to Move

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Two-thirds (or more) of homeowners with mortgages are content with rates below 4% and feel stuck. They can't afford moving with rates nearly double what they were last year. Wp Enjoy the complete experience. ArrowRight Choose your plan. It might be simpler to fix the things you don't love about your house than it is to buy a new one. It may also be less expensive to renovate a kitchen, add an extension, or upgrade an old bathroom.

How do you finance it? Although there are few great options, second mortgages might be worth a look. This product was in disrepute during the Great Recession.

Second mortgages sound exactly like they do: Borrowers tap into the equity in their home to obtain a lump sum at an agreed rate (typically for 20 year), while still maintaining the original mortgage. These are also called home equity loans. These loans are different from home equity credit lines, which have variable rates and the same amount. They are also different from cash-out refinances where the old loan is replaced by a new one.

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Borrowers still have a great time to turn to their homes to get cash. Although home prices are down 4% from 2022's highs, they have increased 39% since the outbreak of the pandemic. This means homeowners have a record amount of equity in their homes.

Second mortgages are now subject to bona fide underwriting and income documentation, thanks to the sensible safeguards that were put in place after the housing crash. The limit on the amount you can borrow is also determined by lenders. This cap is based on the home's value.

A second mortgage is not a good idea for any purpose. A second lien is a smart option for those who intend to use the proceeds to renovate their home or repay higher-interest debts. You probably won't want another source of funding for home renovations like stock portfolios.

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Remember that second mortgages are typically smaller than first mortgages. Rocket Mortgage has a cap of $250,000 but an average of $75,000 according to Bill Banfield, Rocket's executive vice president for capital markets.

Second mortgages are more expensive than cash-out refis. Laurie Goodman, an Urban Institute fellow, provides an example of how borrowers might end up paying more with a cash out refi.

A borrower who wants $100,000 in home equity through a cash-out refi will likely pay 6.5% on the new balance, which would result in a monthly payment $1,896. However, if you keep your existing mortgage at 3% and take out a second lien at 11% (which is even higher than Bankrate’s average), the total monthly payment for both loans would be $1,760.

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The best deal for a cash-out refi or second mortgage will depend on the borrower's particular situation and other factors, such as their original mortgage rate, how much they are looking to borrow, and their credit scores. A higher score usually means a better rate. There are many calculators that can help you make a decision. Here's one that calculates your home equity, and another that allows you to compare the options.

Cash-out refis can also be an expense. These closing costs can amount to as high as 6% of total loan value. Lenders tend to pay most of the closing costs for second mortgages.

A home equity credit line of credit is another option for those who need cash to renovate. HELOCs are now only available to those with impeccable credit. According to Goodman, nearly half of all home equity line of credit originations last year were made by borrowers with credit scores greater than 780.

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Remember that your home equity credit rate and your payment amount fluctuate based on the prime interest (which is higher than federal funds rate) plus/minus a margin. A HELOC is not the right choice if you are looking to budget around a fixed payment amount.

Be sure to compare rates before you apply for a second mortgage. Although they aren't very common at traditional banks, lenders like PennyMac and Rocket Mortgage have recently introduced them. According to Equifax, the second mortgage origination market grew 50% from the previous year to $53 billion between January and August 2022.

This is because more homeowners will feel secured by their fixed-rate mortgages pre-2022.

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This column is not intended to reflect the views of Bloomberg LP or its owners.

Alexis Leondis, a Bloomberg Opinion columnist on personal finance, is Alexis Leondis. She previously managed tax coverage at Bloomberg News.

More stories like this are available on bloomberg.com/opinion

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