How Much Can You Borrow?
If you will require a loan to pay the cost
of your remodeling project, you may have several options to choose from.
However, a limiting factor is how much you can borrow. Determining
your available credit is an important first step in planning your
project.
When applying for a loan, you will probably be
required to specify how much you want to borrow, or if you apply
for a line of credit, what credit limit you seek. Therefore, you
need to have an idea of what your project costs will be. You don't have
to have firm bid to get started, but you do need a good idea. The problem
with getting a firm bid is that you will need plans drawn, at least for
a large project. However, it may be a waste of money to have plans drawn
up if you can't afford the project in the first place.
Getting an Estimate
Determining the cost of the project is not an
exact science. There are so many variables, that determining the exact
cost is usually impossible. However, it is possible to get a good general
idea. There are books on the market, that break down the cost of various
work, adjusted for regional differences. The problem is that these books
require you to know which work will be required. There are cost estimators
on the web, that give a very rough idea of cost, but they do not take
everything into consideration. If the estimator does not adjust for regional
variances, usually by asking for your zip code, then the cost may be
grossly inaccurate. Another option is to start interviewing contractors
now, and when you meet with them, ask them to provide a rough nonestimate
based upon your project description.
In addition to estimate, you should add a contingency
figure, to allow for the unexpected. Ten percent is a commonly suggested
figure. If you will move out during construction, add on the cost paying
rent (remember, your mortgage payment will still have to be paid). Your
estimate may not include the costs of permits, fees, engineering costs,
architectural design costs, printing of blueprints, and a myriad of other
expenses that can add up. Finally, an additional cushion should be available,
just in case. This extra cushion may be need to be as much as 30%. Running
out of money before the project is not a position anyone wants to be
in.
LoantoValue Ratio
Lenders consider a lot of things when evaluating
your loan application. But if you are putting your home up as security,
one thing they all look at is you loantovalue (LTV) ratio. Bottom line,
your lender wants to know that no matter what, they will get their money
back. That means in a worse scenario, they will have to foreclose on
your home and sell it to get their money back. They want to be sure they
can sell it, pay off any senior mortgages and have enough left to cover
their loan and accrued interest.
To calculate your LTV ratio, start by adding together
the balance of all your mortgages on your home, plus the amount you want
to borrow. Now divide this figure by the estimated value of your home.
For example, let's assume a 1st mortgage balance or $150,000, a 2nd
mortgage of $25,000 and you will need $50,000 for your remodel project.
Add these figures together for a total of $225,000. If your home is worth
$450,000, then divide $225,000 by $450,000, which results in a 50% LTV
ratio. This means that half the value of your home is encumbered by mortgage
debt and the rest will serve as a cushion to protect the lender.
Most
lenders like a LTV ratio of 70% or lower, although a few will lend up
to a LTV ratio of 100%. To calculate the maximum amount
you can borrow, multiply the value of your home by the maximum LTV ratio
your lender offers and then deduct all existing mortgages. The remaining
figure is the maximum loan amount. Using the example above, $450,000
x 70% = $315,000  $150,000  $25,000 = $140,000 maximum loan amount.
Your Ability to Repay the Loan
Your lender wants to know that you will be willing
and able to repay your loan. The two most important factors they consider
are your credit score, which demonstrates your past history of bill payment,
and your income, which proves you will be able to afford your new payment.
Your credit score will have a direct affect on
the interest rate and fees you pay and thus on how much the payment will
be and ultimately how much you can afford to borrow.
Your income versus your expenses is referred to
as your debt ratio. Add together all of your payments, mortgage, credit
card, car loan etc. and divide that by your gross monthly income. That
figure is your debt ratio and lenders like that to be no higher than
36%. If your new payment will put you over that threshold, you may still
be eligible for a loan, but the interest rates and fees are likely to
be higher.
Loan Costs
Your loan costs are the interest rate you will
pay and any fees or points that will be charged. The higher the rate
and fees, the less loan you can afford. Therefore, you may want to choose
a loan type that offers a low initial interest rate. You will be able
to qualify for more, and during the initial term of the loan, you will
have lower payments. Later, the
interest rate and payments will increase, presumably as your income and
thus your ability to afford them increases.
Longer loan terms stretch out how long you have
to repay the loan and reduce the monthly payments. However, you pay substantially
more in interest on a longer term long. To lower you payments, choose
a longer term. To lower the amount of interest you pay, choose a shorter
term. In some cases, shorter term loans also come with slightly lower
interest rates, an additional incentive to take a shorter term loan.


