You’ve run out of room in your home, now what? Do you move or do you put an addition? Only you will know which option is right for you, but generally, you can obtain financing for the new addition if you have good credit and room in the equity of your home. If financing the addition is an option for you, it is usually the less expensive route to go.
Figure out what you Need for the New Addition
First, you need to figure out what you need. Talk to a licensed contractor and/or architect to determine what it would take to put an addition on your home. Unless you have the qualifications to do it yourself, hire a professional. Just the consultation should not cost you too much and it could save you many headaches in the future. The professionals know the type of work the house needs as well as a ballpark estimate of the costs. They will pass this information along to you to help you figure out your next step.
You should always add at least 10 percent onto the quotes contractors give you. This allows you to account for any mistakes or surprise emergencies that occur. Without this extra reserve, you could find yourself in a serious financial bind.
Determine your Qualifying Factors
Once you know the amount of money you need to put on the addition, you need to figure out what type of financing you qualify to receive. There are several options including:
– Home equity loan
– Home equity line of credit
– FHA 203K renovation loan
These options each have different qualifying factors you must meet. In order to determine what you qualify for, consider the following factors:
– Your credit score
– Your credit history
– The value of your home
– Your debt-to-income ratio
– The stability of your employment/income
Each of these factors plays a role in the type of financing you can receive and every lender will require different qualifications.
What is your Loan-to-Value Ratio?
If you want to take out a home equity loan, your loan-to-value matters a great deal. Most lenders do not lend out more than 80 percent of the home’s value if you take a line of credit. This means that you receive a specific amount of money in an account, like a checking account, which you can use to fix up your home. You can draw the money out by writing checks and pay it back whenever you can during the draw period. If you pay the money back, you can use it again during that draw period, which is usually 10 years.
A fixed home equity loan can sometimes be worth as much as 85 percent of the home’s value. This is because you receive a fixed amount of money all at once and have fixed payments to pay it back. This type of loan is slightly less risky for the lender, which is why they can loan you a little more in terms of the loan amount.
The FHA 203K program is the most liberal program in terms of the loan-to-value ratio. If you use the full 203K program, which allows you to make as many changes as you want with very few restrictions, you can borrow up to 110 percent of the future value of the home after the contractors complete the addition. Just like any other FHA program, the 203K program has liberal qualifying requirements, allowing you to fix up your home even if you have lower than average credit.
What is your Credit Score?
Your credit score plays an important role in the type of financing you can obtain to put an addition on your home. Obviously, people with higher credit scores have more options. Because a second mortgage takes second lien position on the title, the mortgage holder is in a riskier position than the first lienholder. If something was to happen and you defaulted on the loan, the first lienholder gets paid off first. This might leave the second mortgage holder with nothing, depending on the circumstances.
Because of this risk, you need good or excellent credit to obtain a home equity loan or line of credit. Generally, people with a score lower than 700 find it hard to find a home equity loan, but they are out there, typically with portfolio lenders, otherwise known as subprime lenders. If you have other compensating factors, such as a low debt-to-income ratio and plenty of assets, you might be able to convince a lender to provide you with a home equity loan.
If you do not have “good” credit, you might still qualify for the FHA 203K loan. This program allows credit scores all the way down to 580. Not every lender will allow a credit score this low, but there are some out there. If your credit score is below 700, but your credit is fairly good, meaning you do not have any late payments; you are at least two years out from any bankruptcies; you are at least three years out from any foreclosures; and you do not have an excessive amount of outstanding credit, you could be eligible for the 203K program.
What is your Debt-to-Income Ratio?
The debt-to-income ratio plays an important role in your ability to obtain financing for a new addition on your home. On most home equity loans, a debt ratio of less than 45 on the back-end is recommended. This means that your total debts, which include your first mortgage (principal, interest, taxes, and insurance); the second mortgage payment (principal and interest); car payments; student loans; and credit card payments all total less than 45 percent of your total monthly income.
Just like every other factor, the FHA 203K program might offer a little more leniency when it comes to the debt ratio. The FHA program looks at every aspect of your loan as a whole, rather than looking at individual factors. This enables you to have compensating factors, like we talked about above, and still get the FHA 203K loan with a higher debt ratio.
Obtaining financing for a new addition on your home will definitely take more work than your first mortgage took, but it is well worth it. If you have the option to add onto your home rather than picking up and moving, it is generally the cheaper route for you. Not to mention the fact that there is much less work and headaches involved in fixing your home up rather than moving!