•Choose the financial option that's best for you.
•Get the basics on loans and refinancing.

Deciding to build, renovate or remodel a kitchen or bath involves a host of decisions, not the least of which is how to pay for the work.

The easiest and least expensive way to pay is up front, with cash. For most homeowners, however, coming up with the considerable sums required is as difficult as mining natural stone.

Paying with a credit card can be as easy as cash. However, unless you’re doing a simple home repair or a modest upgrade, it’s best to leave those cards tucked safely in your wallet. Soaring interest rates make credit-card financing the most expensive way to pay for a renovation.

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The good news is that affordable financing options, from refinancing to various renovation loans, are readily available from your bank or lending institution. And securing financing is less of a hassle than you might think, especially if you work with a bank with which you already have a current relationship.

Which financing option is best for you? Consider these common options:

Construction loan

A short-term loan from a bank or savings-and-loan institution. It is paid to the builder in increments or draws at set intervals during the building process.

Terms and loan options: This is typically a six- to 12-month loan. Homeowners make interest-only payments on the amount advanced to date, and the loan is due when the project is completed. Lenders often offer these loans as a package deal, with the long-term mortgage paying the construction loan.

Pros and Cons: There's only one lending institution to deal with, one approval process and closing, and one time to pay for application and closing fees.

What to consider: This is a good option if your project is so large that a home equity just won't do. It’s ideal if you're adding a second story, doubling the footprint of your home or gutting your house to the studs and then rebuilding.

What the bank needs: Besides standard documents, you'll need to supply detailed plans of your project so the lending institution can pay the contractor in draws during the construction process.

Home equity

This loan uses the equity you've accrued in your house for collateral. It provides a significant loan amount for a reasonable interest charge, and the first $100,000 is usually tax-deductible.

Terms and loan options: The maximum loan amount is 70 to 80 percent of the value of the house minus the outstanding mortgage. There are two options: A lump-sum second mortgage at a fixed interest rate, or a revolving line of credit with an adjustable rate.

Pros and Cons: The equity credit line allows you to draw money and repay it as you need to. This option can, however, put your house at risk if you're unable to repay the loan.

What to consider: When comparing home-equity loans, consider rates, the length of the loan and any up-front or ongoing fees. You may want to ask your financial advisor about a fixed-rate lock option, which allows you to switch from a variable rate to a low, fixed rate on all or a portion of your line of credit.

What the bank needs: Standard documents, including recent bank statements, recent W2 forms, and pay stubs, and records of current outstanding debt.

Refinancing

With this type of financing, you replace your existing mortgage with a larger one and use the extra cash to pay for improvements or repairs.

Terms and loan options: A huge array of options exists, from interest-only options to various types of adjustable mortgages. For example, a 40-year mortgage could be a smart way to finance a major renovation, such as a second-story addition.

Pros and Cons: If interest rates have dropped since you took out your primary mortgage, refinancing will lower your monthly payment. Refinancing provides remodeling funds at low mortgage-interest rates, while the long-term loan (usually up to 30 years) keeps the monthly payment down.

What to consider: If you already have a mortgage, check whether your current lender streamlines the refinancing process and offers low-cost options. Don’t forget to weigh the high up-front costs for the application, appraisals, title insurance and points before making a decision.

What the bank needs: Standard documents, including recent bank statements, recent W2 forms, and pay stubs, and records of current outstanding debt.

Personal loan

A personal loan is secured by your signature rather than with your property.

Terms and loan options: These come with higher, nondeductible interest charges, and a short repayment period.

Pros and Cons: A good option if you lack home equity or prefer a fast loan for a small project. With good credit and sufficient income, you can often receive an unsecured loan for up to $25,000. However, there are high, nondeductible interest charges.

What to consider: You may be able to reduce the interest rate if you can offer some form of collateral such as property, or savings or securities accounts.

What the bank needs: As with a construction loan, you'll need to supply detailed plans of your project so the lender institution can pay the contractor throughout the project.


As for future trends in renovation financing, Nancy Elkus, vice president of Fifth Third Bank, a Midwest banking system, says the lines separating mortgages and home equity loans will continue to blur.

Already, the rise in 40-year mortgages is prompting banks to offer longer term home-equity loans. Banks also are offering adjustable rate equity products that work much like five-year adjustable rate mortgages.

Likewise, mortgages continue to resemble equity loans. “A hot product is the interest-only mortgage, so that even with refinancing, you can pay interest only,” Elkus says. She adds that about 30 percent of all mortgages now booked by banks are interest-only.

Before choosing any renovation financing option, however, first discuss with your financial advisor which options are best for you.