Home Equity Loans and Lines
Many people feel that the best way to finance home improvements is with a home equity loan or home equity line of credit. Lenders allow homeowners to take out home equity products in the first or second lien position. This means that someone with an existing mortgage can take out a second loan against their home if it has sufficient equity. Most banks allow people to borrow up to 80 percent of the value of their home between their first mortgage and second lien. Someone with a $150,000 mortgage on a $200,000 house, could borrow $10,000 in the form of an equity loan or line.
Home equity loans have fixed interest rates and terms that normally last for between 10 and 20 years. Home equity lines of credit work in the same way as credit cards but are secured by residential properties.
Typically, home equity lines of credit have variable interest rates, which move in conjunction with the prime rate. If the prime rate is low, the interest rate on a line of credit is also low. If the prime rate begins to increase, line of credit rates rise in conjunction with it and most lines of credit have maximum rates of 18 or 20 percent.
People who use lines of credit generally only do so if they plan to pay a the lien off within a few years. Most revolving lines can be used for up to 20 years, but keeping a significant balance on a variable rate product for that long exposes homeowners to the risk that payments may become prohibitively high in the long-term. With fixed rates that are usually close to mortgage rates, home equity loans are usually the best way to finance home improvements if people plan to pay off the proceeds over a lengthy period of time.