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Total Financial Makeover
Financing Options for Home Improvement
April, 2006 - Issue #18
Improvements to your home can be a costly venture. If you are doing it yourself or using an outside contractor, knowing which financing method to use can save you money.

In order to make the right decision, here are some questions you should ask yourself: How long is it going to take to do the entire job? What will the total cost be? Do I need money for other home improvements in the near future?

Your answers will determine which financing option you should use. You will need to decide whether to use a home equity loan, a home equity line of credit, borrowing on your 401(k), borrowing from your portfolio, a life insurance loan, or a Title 1 loan.

Home equity loans and home equity lines of credit (HELOCs), let you use your home's equity without having to sell the home. If you are planning a one-time project, a home equity loan is preferred. These loans are for those who need a specific amount of money and payment stability. They offer a lump-sum payment and allow for a fixed monthly payment until the loan is paid.

If you are involved in an open-ended project, a HELOC is the most flexible option. Surprises, like inaccurate estimates, can cause you to pay more than anticipated. If you are doing it yourself, you might underestimate the materials needed or, even worse, break something. Home equity lines of credit typically are a good deal if you want a lower up-front rate and access to money at unpredictable times. With a HELOC, you can open it and you're only going to pay for the amount you use, plus interest on the amount you've withdrawn.

Borrowing on your 401(k) for home improvement can only be used if your employer allows it. You don't have to deal with credit checks, and you can borrow at low interest rates and less of a wait.

However, this is supposed to be the "rest of your life" money that you've been putting away since you started your job. If you leave your job after having borrowed from your 401(k), you will have to pay back the loan in full or pay about 30 percent in withdrawal penalties and taxes. Pulling from your 401(k) puts a hole in your retirement planning. Even though the interest you pay on the loan goes into your retirement account, the balance after the loan is paid could likely be lower than it would have been had you not borrowed.

A life insurance loan involves borrowing on the cash value you've built up in your whole life, universal life, or variable life insurance policy. It's easy because it requires no credit check and you can pull up to 96 percent of the policy's cash value. The frightening thing about this loan is that it may lessen the death benefit. This means that if you die before the loan is paid off, your family will receive a smaller payout.

Margin loans, borrowing from your portfolio of securities, are also an option. You may be allowed to borrow up to 75 percent to as much as 95 percent of the value of the securities. In addition, there is no credit check and the loan doesn't have to be paid back if the market does well. What you must understand about borrowing from your portfolio is that you are using your securities as collateral. If the market drops, so does your collateral and you may be forced to sell your securities to keep the loan secure.

If you are a new home buyer or have limited equity, you may qualify for a Title 1 loan. These loans come from banks and other lenders but are insured by the Federal Housing Administration. You can negotiate the interest rates with the lender, but the loan can't be used for luxury improvements. If you are a person with a disability and wanted make your home wheelchair accessible, a Title 1 loan could be used.

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Jeff Springgate is a Financial Counselor for Total Financial Solutions, Inc. and is co-host of a financial radio show on Tuesdays and Thursdays from 1pm to 2pm on KHTS AM1220.
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