By Stephen Fournier, President, Central New York Market, KeyBank
For many homeowners, HGTV has become a staple network for television viewing. With shows on home renovations and house hunting, it’s reality television most people can relate to.
However, for those who are really considering buying, selling or renovating, the top 5 cable network, while entertaining, doesn’t always depict reality. The average home renovator doesn’t receive sponsorship discounts for materials, nor can a kitchen remodel be completed in a day. It’s also not as easy to blast past your budget for the home of your dreams.
Still, these shows are striking a nerve for good reason. According to CNBC’s Realty Check, home equity is at a record level and market confidence is high. The result is many people are interested in either transitioning to or purchasing a new house that better meets their needs. The question is, which is right for you?
Should you stay or should you go
There are some obvious reasons to move. You need to relocate for work. You want to move your kids to a stronger school district. Your starter house was never the home of your dreams. Or maybe you’re older, the kids have moved out and your house is simply too much house.
The dilemma arises when you love your house and its location, but it just doesn’t work for you anymore. Here are some questions you can ask yourself that may help provide clarity.
- Can you renovate in your existing square footage? It is often more cost effective if you can remodel within your home’s existing footprint, and often people need a smarter layout more than they need added square footage.
- What can you fix, and what can’t you replace? From location to exterior design and ceiling height, some features of a house are difficult and costly to replace. On the flip side, some things, especially in older homes, are difficult if not impossible to replace, including materials, craftsmanship and history. You need to know what you can cost-effectively update, and what you cannot.
- Are you tough enough? Living through a renovation can be extremely disruptive and is not for everyone. You could be without kitchen and bathrooms for extended periods of time, not to mention the noise and dust?
- Will improvements make your home easier or harder to sell? Always consider your long-term plans and the possibility you may eventually sell your house. Are the improvements you’re making in line with other homes in the neighborhood? It is possible to over-improve for your neighborhood, which will make it difficult to earn top value for your house, as well as make it more difficult to sell.
- What type of return will you generate? This is where renovation shows are most misleading. Yes, the improvements you make will increase the value of your home, but home improvements typically do not pay for themselves. In fact, most improvements can expect to recover 50 to 90 percent of their cost.
If your current location is desirable and you plan to stay in your location, the big question to ask is what makes the most sense financially. How much equity do you have in your home? What will your new rate be? Would a home equity loan or line of credit to make improvements be more cost effective than taking out a new mortgage for a new home?
Understanding home equity
Home equity is the value of a home minus any mortgages or liens owed. For example, if a house is valued at $300,000 and the remaining balance on the mortgage is $150,000, the owner of that house has $150,000 in equity.
For homeowners looking to sell a property, positive equity equals profit, which can be used as a down payment on a new house. For all other homeowners, equity equals borrowing power, which is available in the form of home equity loans and home equity lines of credit (HELOC).
A home equity loan provides a one-time lump sum payment that the borrower repays in equal payments over a fixed period of time. A home equity line of credit (HELOC) provides cash as needed, at various points over a period of time. Payments will vary depending on the outstanding balance, and more funds become available as the loan is repaid, replenishing the line of credit.
A home equity loan is ideal for a large one-time expense, such as buying a car or consolidating bills. If you have ongoing financial needs, such as home improvements, business expenses or life events, than the HELOC will likely be a better option for you.
How to get started
When it comes to borrowing against the equity in your house, the usual ability-to-repay qualifiers apply: assets, income, credit history and current financial obligations.
Talk to various lenders and learn about the lending programs they offer. Also, be prepared. You can streamline the process and get more accurate information if you do the following:
- Review your budget.
- Obtain your FICO score and find ways to improve it. KeyBank’s HelloWallet financial wellness tool can help with budgeting and paying down debt.
- Collect paperwork and documentation, such as W-2 forms and pay stubs. If you are self-employed, have your two most recent tax returns.
For more information on programs, requirements and application procedures, contact your local banking representatives.
About the author: Stephen Fournier is president of KeyBank’s Central New York Market. He may be reached at either 315-470-5096 or [email protected].
The three R’s of home equity financing
Like any other form of credit, the funds you borrow against your house need to be paid back, with interest, to the lending institution. However, unlike other forms of credit, specifically credit cards, your home equity loan or line of credit is not unsecured. This means that your house serves as collateral, and your obligation can’t be wiped out through bankruptcy.
For most borrowers, though, the benefits outweigh the risks. To make sure this is the case for you, you should consider the three R’s of home equity financing before making any decisions:
- The Reason. Every homeowner has many possible reasons for needing extra cash, and home equity financing opens up new possibilities. Uses include financing home improvements, vacations, education, retirement, debt consolidation and business opportunities. Understanding the reason is important because it can help you determine whether a home equity loan or a home equity line of credit would be more advantageous to your situation.
- The Rate. Home equity financing is available with either a variable or fixed interest rate. A variable rate plan allows borrowers to take advantage of decreases in interest rates when the bank lowers the prime rate. A fixed rate “locks in” an interest rate at a certain percentage and at a certain point in time, so the borrower has the security of knowing that the interest rate will remain the same over time.
- The Relationship. Interest rates, closing costs, payment schedules and prepayment penalties for home equity loans or lines of credit vary somewhat at different banks. Talk to various lenders, and keep in mind that financial services are ideally relationship based. Your satisfaction will depend on the trust and professionalism of the lender, as well as how well they align products and services to your short- and long-term financial goals.
It is also worth noting that in most instances home equity loans and lines of credit are preferable to accessing funds by withdrawing them from an IRA or liquidating other assets, because such withdrawals often entail penalties or even capital gains consequences. In addition, unlike credit cards, interest rates are typically low on home equity products, and the interest is often tax deductible.
