With interest rates on the rise, many homeowners are hesitant to make significant decisions where their homes are involved. Whether it’s a loan for purchasing a home, remodeling, or refinancing, high interest rates make it difficult to know when and how to invest money into your home.
At Lamont Bros., our team of remodeling experts has navigated these volatile market cycles before. In its current state, there are certainly more challenges to consider before making a major home financing decision. However, under the right circumstances, you can use high interest rates to your advantage.
This article will discuss how high interest rates can affect a home remodeling loan. By the time you finish reading, you should have a strong understanding of what options are available to you and the best course of action for your specific situation. Topics we’ll cover in this article include:
- Recent trends in mortgage interest rates
- Popular remodel financing options
- How to decide on a financing plan for your remodel
Why are interest rates going up?
Interest rates have been in the news a lot throughout the latter half of 2022. With record-setting increases, a lot of homebuyers and homeowners find themselves reconsidering whether now is the right time to purchase or remodel a home. But what exactly is going on with mortgage rates, and why?
Housing Market Woes
Ask anyone who’s tried to buy a house in the last two years and they’ll tell you the same thing: buying a house is a nightmare in today’s market. As a response to the COVID-19 pandemic, the federal government reduced interest rates in 2020. During this time, 30-year mortgage rates reached 2.68%, an all-time low.
From 2020 to 2021, home prices rose by 22%. By 2022, the American housing market was characterized by shockingly high prices, rapid home selling, and bidding wars. Recognizing that something needed to be done to combat rising home costs and inflation, the Federal Reserve Board began enacting measures to slow the housing market’s growth.
Interest Rate Hikes
In February of 2022, the Federal Reserve announced that it would begin to raise federal interest rates, which affects short-term financing rates like credit cards and car loans. It also affects home mortgage rates, though not as directly.
The Fed began in March of 2022 with a .25% rate hike. Several more rate hikes followed, and by November 2022, interest rates were up 3.75% in 8 months, the fastest rate of increase in American history.
Though federal interest rates don’t directly affect mortgage interest rates, they do have some influence. Between March and November of 2022, mortgage rates climbed from 3.76% to 7.08%.
But How do Interest Rates Affect the Housing Market?
Rising interest rates drive up the cost of owning a home. The monthly mortgage payment on a $600,000 home with an interest rate of 3% would cost about $2,500 per month. The same home with an interest rate of 7% would cost $4,000.
When interest rates drive up home purchase prices, fewer people can afford to buy one. This decreases demand, which in theory should reduce home prices. As of October 2022, that principle seems to be holding true, as average home prices have dropped for the first time in 2 years.
What are my Options for Financing a Home Remodel?
High interest rates can have a major impact on which loan options make the most sense when remodeling your home. Here are some of the most popular renovation loan options available.
Home Equity Loan / Line of Credit
One of the benefits of a housing market boom is that homes generate equity very quickly. The average home has increased in value by 35% in the last two years. Oftentimes, homeowners use the equity in their home to fund a renovation project.
A home equity loan functions like a second mortgage with its own separate interest rates and monthly payments. With this type of financing, you borrow against your home’s equity for a lump sum, which you can then use to pay for the renovation.
Slightly different from a home equity loan is a home equity line of credit (HELOC). With this approach, you still borrow against your home’s equity. However, instead of receiving a lump sum, you only take out what you need when you need it.
During this initial draw period, your home equity line of credit functions like a credit card. You can spend money up to a certain amount and make small payments on it as you draw. After the draw period, you enter the repayment period, during which you stop drawing from your equity and instead begin repaying the borrowed amount.
Cash-Out Refinance
Often a much simpler option than a standalone home equity loan, a cash-out refinance is a great way to finance a remodel if you were already planning to refinance your home. With this type of loan, you roll your mortgage and equity loan together into one consolidated loan at a higher monthly payment.
A cash-out refinance is an especially good option when mortgage rates are low because it gives you the opportunity to both refinance your home for a lower rate and secure funding for a renovation. However, when interest rates are high, a cash-out refinance can drastically increase your monthly mortgage payment.
Renovation Loan
In some cases, homeowners may choose to pursue a loan that is specifically designed for home renovations. These options are especially popular for homeowners who want to be able to borrow against the value of the completed remodel. Often, this is because the equity in their home would not pay for the total cost of the renovation. However, a renovation loan does completely replace the traditional mortgage, so this approach is less popular when interest rates are high.
Federally backed renovation loans, such as the Sallie Mae HomeStyle Loan, come with the benefit of having low down payments. However, they also come with a lot of bureaucratic red tape and lots of hoops to jump through. A federal renovation loan requires inspections and approval of design plans before, during, and after the renovation.
Alternatively, private renovation loans are where many of our clients at Lamont Bros. have found the most success. Although down payments tend to be higher, private loans are less strict with inspection requirements. Because private loans are often done through local banking institutions, you’re also more likely to end up with a financing plan that is a better fit for your own personal needs.
How to Decide on a Remodel Plan When Interest Rates are High
When mortgage rates are high, the right financing plan for your remodel will depend on two main factors: your current home interest rate and the cost of your renovation. Here are a few things to consider when making a decision.
If you currently have a low interest rate, keep it.
Interest rates aren’t expected to come back down until mid-2023. Even then, we’re not likely going to see rates anywhere close to what they were in 2020 and 2021. If you’re one of the lucky ones who managed to snag a 3% interest rate, you’re in a really good position. To buy a home of the same value as the one you’re currently in at today’s rates would likely cost you over 60% more per month.
A lot of homeowners are finding themselves in the position of wanting a new home but not wanting to give up their low interest rate. Fortunately, remodeling your current home can solve a lot of the same problems as buying a new home, and it won’t raise your entire mortgage interest rate if you remodel using a separate loan.
If you plan to use your home’s equity, it’s better to use a home equity loan or line of credit than a cash-out refinance. By keeping your renovation financing on a separate mortgage, you can avoid having to change your primary mortgage’s rate. That way, you’ll only be paying a higher interest rate on the equity loan and not the entire home.
If you have to buy, buy now, refinance later.
Maybe remodeling your current home isn’t an option for you. Perhaps instead, you’re thinking about buying a fixer-upper and renovating it. In this case, you may be wise to take advantage of stagnant home prices caused by high interest rates.
This is based on the prediction that interest rates will eventually go down again. As rising interest rates slow the growth of the housing market and in some places even drive home prices down, you might be able to lock in a good price on a home in need of some remodeling with a high-interest loan. However, if interest rates fall back down in a few years, you can refinance the mortgage to a lower rate.
Unsecured Personal Loan
One option that is becoming more popular as traditional mortgage rates increase is the unsecured personal loan. An unsecured loan does not require collateral, so you don’t borrow against anything. As a result, the loan term tends to be shorter (12-60 months) and the maximum borrowable amount is capped around $75,000.
Although the loan term tends to be shorter, a personal loan doesn’t require refinancing your original mortgage or borrowing against the equity in your home. Unsecured loans can be a great option for homeowners who want to remodel, especially when mortgage rates are high. Personal loan rates start at 0% for the first 12 months, then increase to 5% – 8% for up to 5 years. So sometimes, the interest rates on a personal loan are lower than a mortgage.
It’s important to recognize that, because the loan terms are shorter, the monthly payments will be larger with a personal loan than with a mortgage.
Want to learn more about home remodeling?
Now that you understand more about how high interest rates can affect a remodeling loan, keep researching your options! One important step in securing financing for a remodel is finding a contractor who keeps you in charge of the cost of your remodel. To learn more about how the design-build process can help you have a stellar remodeling experience, check out our Process Page.
Thinking about a remodel and want to start exploring your options? Click the button below to schedule a free design consultation with a member of our design team. We’ll help you face the challenge of remodeling your home so you never have to face it alone.