Consider these 4 things before financing a home improvement

Saturday, 20 January 2018 00:49 Written by  Read 6 times
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With Goldman Sachs’ newest loan product, the money-center bank is making a smart bet.

Goldman Sachs GS, +2.05%   announced Tuesday that it will begin offering home improvement loans through Marcus, its consumer-focused subsidiary. It comes at an opportune time. Home remodeling is set to surge at the fastest pace in more than a decade. Borrowers can get loans in amounts ranging from $3,500 to $40,000 for a period of three to six years. The loan product carries no fees — consumers who make late payments will only be required to pay the interest for those additional days — and the bank has said it can fund the loans within five days for creditworthy borrowers. Rates currently range from 6.99% to 23.99% APR.

The product is coming to market at a time when American homeowners are especially eager to take on home improvement projects. In 2017, home improvement spending increased 17% from the previous year, said Robert Dietz, chief economist for the National Association of Home Builders, citing U.S. Census data.

The spending increase has been fueled in part by people staying in the same home for longer, which has resulted in a scarcity of homes on the market, Dietz said. Consequently, home values have risen nationwide, leaving homeowners with a larger pot of equity to dip into to fund improvements. “When you have existing homeowners with more wealth and reduced mobility that’s going to increase demand for improvements,” Dietz said.

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Older Americans in particular are investing in renovations and upgrades, such as wheelchair accessibility, that will allow them to age at home and avoid moving to a facility. Energy efficiency upgrades have also increased the demand for renovations. And some owners may be making improvements because certain home improvement projects can translate into a higher home value.

Meanwhile, the costs associated with completing a renovation project have ticked up as a result of labor shortages and more expensive supplies, Dietz said. All told, Dietz said he expects home improvement spending to increase 7% over 2018 — but he wouldn’t be surprised if it went even higher. “Remodelers are going to be busy,” he said.

Here are some points to consider before moving forward with a renovation project:

Personal loans like Goldman Sachs’ offering could make more sense these days

The tax legislation signed by President Trump in December eliminated deductions for second mortgages, home equity loans and home equity lines of credit — all of which were popular methods for financing home improvement projects.

The ability to deduct the interest on these loans was previously a major selling point for them versus personal loans like Goldmans Sachs’ new product, said Greg McBride, chief financial analyst at personal-finance website Bankrate.com. “The loss of the deductibility of interest really leveled the playing field,” McBride said.

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There are many reasons why personal loans may be more attractive, even if they carry higher interest rates. They aren’t secured by property like home equity loans are. The rate on personal loans is typically fixed, unlike home equity loans. There are fewer additional costs associated with taking out of a personal loan, and an appraisal isn’t necessary. Plus, many personal loans can be funded within a matter of days.

But what about the growing amount of personal loan-related debt? McBride said these issues won’t be relevant for most borrowers considering a home improvement loan. “The lion’s share of demand for personal loans tends to come from consumers who don’t have the sterling credit profile,” he said. People seeking home improvement generally have other financing options and assets at their disposal, he added.

For some, home equity loans could still be the better option

Home equity lines of credit, or HELOCs, are a more flexible option for borrowers, because consumers can choose to draw on them at their own pace over a longer period of time. That could be useful if a homeowner is planning to complete a certain project in stages.

There are also more options for repaying the loan. “If a homeowner is largely paid on commission or through bonuses, their income during a year is very lumpy,” McBride said. “They may not want to lock themselves into a big monthly payment that’s fixed but rather have the flexibility of lower monthly payments when income is lean and make larger payments in months where they are more flush.”

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The average rates available for home equity loans and a $30,000 home equity line of credit as of last Jan. 10 were 5.39% and 5.62% respectively, according to Bankrate.com — though often lenders will offer a one-year introductory rate that is below that. And the adjustment to the higher, variable rate following the introductory period can be a shock to some borrowers. Plus, there’s always some risk involved when taking on more debt, particularly for people who are approaching retirement.

Cash-out refinances: Who do they work for?

A cash-out refinance is another option. Homeowners who refinance up to $1 million in mortgage debt that existed before Dec. 14, 2017, will be able to continue to deduct the interest if the new loan does not exceed the amount of debt that was refinanced. So the old mortgage interest deduction can still apply.

But homeowners may want to think twice before refinancing their debt, particularly as interest rates rise. In particular, they should weigh the amount of debt they have outstanding versus the amount of equity they want to cash out for their project. “You don’t want to incur the closing costs and higher interest rate on $300,000 of existing debt just to get a good rate on $50,000 of new debt,” McBride said.

Keep your emergency fund and 401(k) in mind

McBride urged consumers to make sure that they don’t endanger their emergency fund. Financial planners generally recommend that households have enough cash saved to pay for six months to a year of expenses in case of a sudden job loss or other unexpected event. Under no circumstances should a consumer ever finance a home improvement project by taking out a loan on their 401(k). “If you need to borrow from your 401(k) to do a home improvement project, you don’t need to do it,” he said.

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