Most folks know there’s an option with home equity loans, or borrowing against your home’s earned equity. But, did you know that construction loans are an option, too? We’ll dive into what each type of financing is, what they’re used for, and determine which is right for you.
What’s a Home Equity Loan?
Home equity financing is popular and on the rise the last few years. Why? Interest rates have increased, and so have housing prices, while home inventories are short. Many have decided to stay in their current homes, and to remodel or incorporate additions to their domiciles.
What Is Home Equity Financing?
Home equity means the portion of your home you own outright. It’s the difference between how much your home is worth versus how much you still owe on your mortgage.
Home equity lines of credit (HELOCs) are on the rise for multiple reasons. While their rates may be high, like traditional mortgage rates are currently, they are usually at better rates than refinancing. They also allow borrowers to access funds for a long period of time, typically for 10 years. That means homeowners have the flexibility to take varying amounts of money for different sized projects over that timeframe.
For instance: An owner may want to rip out carpet and install hardwood flooring. Once the carpet is out, they realize they need new subflooring, too. With home equity financing, they can take out the flooring amount, then the additional amount for repairs as well once the new problem arises. And if the residents decide they need central air conditioning the next year, they can continue to use that same HELOC for that funding as well.
What’s a Construction Loan?
The major difference between home equity financing and construction loans is what the financing can be used for. HELOCs can be used for a variety of reasons, like paying down debt, college tuition, or paying off a car, though many people use them for home renovation projects.
Construction loans, on the other hand, are more constrained in what they can be used for. They’re used for building a new home or to make major renovations to a current home. Lenders typically ask for detailed plans, budgets, and need a qualified builder lined up before doling out financing for builders.
For example: A major project like finishing an entire basement–complete with a new bathroom, office, wet bar, and bedroom–would fit well for a construction loan. Homeowners can find a contractor they trust, work with them to get an estimate of the project size and price, and then apply for financing.
Which Loan Is Right for You?
As with any type of loan, there’s a great deal to consider before signing on the dotted line. If you’re looking to make updates to your existing home and bring it into the 21st century, either a construction loan or home equity loan could work. But there are several major differences.
Construction Loans
- Purpose: New constructions or major renovations.
- Interest rate: Higher, fixed rates.
- Payment structure: Interest-only payments during construction, then principal and interest payments once building is complete.
- Loan term: Short-term, usually 12-24 months.
- Disbursement: Done in stages during construction based on milestones and inspections.
- Requirements: Strict, including plans, budgets, proof of qualified contractor.
- Best for: Major construction projects where a large sum is needed upfront.
Home Equity Loans
- Purpose: Can be used for home renovations, paying down debt, college tuition, etc.
- Interest rate: Variable rates that fluctuate with the market.
- Payment structure: Flexible options, typically with a flat monthly payment.
- Loan term: Longer terms, with 10-year draws and 15-20 year repayment periods.
- Requirements: Dependent on home equity and creditworthiness.
- Best for: Smaller projects and ongoing renovations, or flexible access to funds.
Construction loans are great for a large, expensive project whereas home equity financing can be better for smaller, ongoing renovations. That’s because construction loans are short-term with higher and fixed interest rates, while HELOCs are longer term and have variable interest rates.
Taking out either kind of loan is a big step for any homeowner. That’s why we suggest you reach out to us at GenWealth Capital Commercial so we can explain any unanswered questions, walk you through the process, and get you the financing you need! Contact us today to learn more about our construction loans and home equity financing for builders.