As we know, remodeling can be very expensive, especially in today’s world, and sometimes figuring out how to pay for that can be tricky. Jon Otten, a Senior Mortgage Consultant at Capitol Federal, shares several financing options to make those dreams or much-needed projects happen.
How long have you been in the financial world?
I’ve worked at Cap Fed for 34 years and have been in my current position for about 17 or 18 years. I’ve seen a few things in different real estate markets, some good and some bad. And we’re definitely in an interesting market right now.
There are lots of different loan options, and every market is different. But Capitol Federal has kind of their offering. Can you talk about several options and when they might make sense for homeowners?
A lot of it comes down to probably three different questions.
- What type of current interest rate the borrower might have on their existing mortgage or loan?
- The size of the project they’re looking to do because that’s going to differ as to what financing option may work out best.
- The amount of equity that they may currently have in their property. In other words, how much is the house currently worth based on what they owe on it? Because that will determine what type of product might be the best fit for their scenario.
Let’s say that someone from Kansas City reaches out to you, and they have a large-scale remodeling project. Where do you start them?
Good question. If they’ve got a lot of equity in their current home, that will drive us to refinance their existing mortgage and do what we call a Refinance Plus mortgage, or it could be a Purchase Plus. A purchase would be if they didn’t own the property already.
But typically, when they’re calling me, they’ve been sent by a contractor, in this case, Schloegel, and they’re looking to do an extensive remodel project. In this case, we will do what we call Refinance Plus. With this loan, we get the bid from the contractor upfront, and when we do the appraisal, we consider the work they’re going to be doing.
In other words, we’re giving them credit for their remodeling project. Maybe they’re doing an expansion, a second-floor edition, whatever it is, we’re going to appraise it as if that work was already done. So, that gives them the ability to take advantage of future equity they will have in that property. Based on that scenario, we will lend up to 80% of that appraisal without PMI insurance or 90% of that appraisal with PMI insurance. PMI is private mortgage insurance, a monthly fee the borrower pays due to the elevated loan-to-value considerations. Either of those options would typically work best on a large-scale project.
Is that loan a standard option among lenders, or is that something unique to Capitol Federal?
That is unique to Capitol Federal. Probably only half a dozen lenders in Kansas City have a product like that where they can give value for future improvements. Pretty much everybody will do a loan off of the existing property equity, but very few lenders have a product that will do it off of future value.
Let’s say that someone bought when the market offered better interest rates, and they’re interested in doing this, but today’s interest rates are slightly higher. What would you recommend in that situation?
Well, it will come down to the project size and how much equity they have again. But let’s say they have enough equity in their existing home, and I’ve done a few of these recently. Somebody owned their house almost free and clear. But they wanted to do some financing for a project. If it’s a smaller project, a lot of times, we’ll do a second mortgage. Those will be a little higher interest rates, so that doesn’t interrupt the existing first mortgage. That stays in place, so they don’t lose the rate they have, and all they’re looking at doing is the second mortgage.
Now, in that case, I’m doing the appraisal based on as-is value; I’m not considering future improvements. So, they’re not getting an inflated appraisal, they’re getting the appraisal based on the current home. And in certain situations, we may be able to use a county appraisal.
You have two options for those. You can get a fixed rate second, similar to a first mortgage. It has a fixed rate and a fixed payment. It’s been done over 10, 15, or 20 years.
Home Equity Line of Credit
Or you can do a HELOC, a home equity line of credit. Depending on the project size, those are typically set up almost like an extensive credit line or a smaller credit line. And they only make payments on whatever portion of that credit line they use each month. So obviously, it starts when they do the project up front, they haven’t used the credit line, so they’re not making a payment, maybe that first month. And then, they do part of the project, start making a payment, do more of the project, and make a more significant payment next month.
And that line of credit stays open for some time, ours is a seven-year period where they can draw against it as much or as little as they want to in those seven years. The rate on those is tied to prime, so it will be prime plus something. In our example, our current rates are prime plus half a percent. That will be if they keep the combined loan value at 80%. If they go above 80%, the rate goes to prime plus two and a half.
They don’t pay any PMI insurance on that loan like they would a first mortgage. We’re self-insuring those second mortgages. That’s why we charge a higher interest rate when the loan-to-value gets about 80%. Cause we’re effectively self-insuring those. So that evaluation comes when they take out that line of credit. Let’s say you have that open for seven years; that appraisal comes right when you take that loan out. They can reapply later if they want to increase the amount; maybe their home value’s gone up, or the seven years is up, and they decide to have a line of credit available. Again, we can just put a new one in place based on the then-current value.
The reason we do the seven years is simply that we want a chance to take a look at their financial situation every seven years. Sometimes we’ll set up a large line of credit, and maybe somebody’s financial situation will change. Maybe they’ve retired and are on more of a fixed income. We may or may not want to leave that line of credit for a hundred or 200,000 under that scenario.
What’s the difference between a home equity line of credit and a home equity loan?
The home equity line of credit is a line of credit, so they’re setting up for a dollar amount and can use any portion of that. The home equity loan would be just a variation, but usually, it’s more of a fixed rate, fixed term type scenario.
For our home equity loan, we would do it at a fixed rate depending on the loan’s value and how long they want to pay. The home equity line of credit will have a variable rate. Anytime prime changes, that credit rate line will go up or down.
Now, on the line of credit, the actual payment is determined by the balance here at Cap Fed. We calculate the payments based on one and a half percent of the outstanding balances that month, and that’s what the customer pays as their minimum payment on the fixed. The payment never changes because it’s a fixed rate fixed term, but they can’t use it again for future improvements. They also can’t use it to pay down/off other expenses like a car loan or credit card. Whereas line of credit they could use for anything conceivably they wanted to.
On the HELOC, they can only deduct the interest if they use it for home improvements, to the best of my knowledge. That’d be something they’d want to consult their tax advisor on.
Are the processes different for the types of loans you’ve discussed?
Yes, anytime it’s a new first mortgage, which would be like the Refinance Plus or simply a cash-out refinance. So anytime we’re doing a new first mortgage, it will probably take around 35 to 45 days to do everything. More paperwork is involved if you’re looking at a second mortgage.
For a home equity line fixed rate, a second mortgage, or anything like that, they typically take 30 days or less to get financing. They could even be a little quicker in certain circumstances, especially if we don’t have to do a new appraisal. If they have enough equity in their current home based on the county appraisal for the second mortgage, we may be able to use the county appraisal on the first mortgage.
So, for example, you were doing just a small bathroom in your home. Potentially, a home equity line of credit might be a good option instead of going through the process of appraising your home and a new mortgage.
That’s correct. Especially if they have a pretty attractive rate on their current first mortgage. The only time it makes sense to do a new first mortgage would be, and we had this happen last year and the year before quite a few times when people had a higher interest rate than our current rate. Then, the refinancing made a lot more sense. But now, with rates going up substantially this year, we’re starting to do more home equity lines of credit, more fixed rate seconds than we are doing cash-out refinances and the refinance pluses.
The other main difference would be closing costs on a first mortgage. You will have a few more closing costs, probably somewhere in the ballpark between $2,500 to $3,500. On a second mortgage, those will be anywhere from zero on a home equity line of credit if we use the county appraisal up to maybe a thousand or $1,100.
So, they will be a little less on the closing cost side on a second mortgage or home equity line of credit.
Is a second mortgage looked at negatively in the financial world, or is it pretty standard?
No, it’s pretty standard. We see a lot of people that do have second mortgages these days. Many financial planners will tell their customers to go out and get a home equity line of credit set up even if they don’t plan on using it because the bank doesn’t charge the customer anything unless they use it.
Having a second mortgage is not anything negative or to be frowned upon. It’s just nice to have the availability to know that, hey, if I ever need money, I can cut a check. Whether that’s for paying off a car, financing a kid’s education, or consolidating credit cards.
What is a personal loan, and how does that differ from some of the loans we’ve discussed? And is that a good option for remodeling?
Typically, not At least on our loans because they’re typically limited to $5,000 or less. Usually, the rates are quite a bit higher. I think the last I looked, they were around 12 or 14%. At that rate, it’d be similar to doing a credit card.
Is there anything a client should know or consider when determining the best loan for them?
Again, a lot comes down to those first three questions I asked. The current interest rate, the amount or size of the project, and the amount of equity they have in the home. Once you have those three things nailed down, you can direct them to what might be the best. And then it might be a matter of what is the best.
How does your credit rating impact these options? Today, we can look at our credit rating on so many different sites and know what it is, but what advice do you have for what type of credit rating you need for some of these?
Capitol Federal will be a little different from most lenders from the standpoint that we hold onto all the loans we originate, which is unique in this Kansas City market. Whether it’s a first mortgage, second mortgage, or home equity line, we plan on holding onto those, so we don’t differentiate our interest rate structure based on somebody’s credit score.
Having said that, many lenders, especially on the first mortgage, will give you different rates depending on your credit score. The market mostly wants a 740 or better credit score to give you their premium pricing. If you drop below 740, start shopping for that loan between different lenders.
I will say that when a bank runs a credit score, it will probably come back a little differently than what clients can see. Ours are really up to date. Sometimes if you’ve had a recent change, opened up a new account, or had a recent late payment that may not have hit your credit score yet, it does on the scores we’re pulling.
Most lenders will differentiate their interest rate based on your credit score, at least in the first mortgage world. On a home line of credit or second mortgage, maybe not quite as much. The average score in America is probably in the ballpark of 680. So, 680 or above is not a bad credit score. You start getting 700 to 750, which is excellent; 750 to 800 is very strong. And then 800 above is just superior. We don’t see tons of credit scores above 800. Probably, if I had to guess, I’d say 8 to 10% of all borrowers in America have a credit score above 800.
Do you have any advice or suggestions for people just starting to look at remodeling or purchasing a new home?
The interest rate will be essential, which everybody is most conscientious about. They also want to look at the servicing we talked about. Will this lender hold onto my loan, or will they sell it? They want to compare closing costs because that does come into the equation. And then just basically the type of project they want to do. For instance, we talked about a large project and the Refinance Plus, there are not many lenders out there doing anything like that.
So sometimes, you are pigeonholed into your options based on what projects or products might be available in the community, but it behooves you to shop around a little bit and do your homework. How long is the lender going to take to get you closed? How quickly do you need the money? All those things start to come into play.