Basement Financing: How to Pay for Finishing a Basement
A finished basement can provide additional living space and may yield a substantial return on investment — over 80%, according to the National Association of Realtors. Still, these rehabs can get pricey, so we can help you find the best basement finishing financing for your budget.
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Home equity loan
Home equity is the difference of the value of your home minus your mortgage and/or any other liens on it. If you have enough equity, a home equity loan is one route for making home improvements.
Lenders usually allow borrowers to use up to 85% of the equity in their home, and the repayment period is usually between five and 30 years. Your credit score will affect the rate you receive — and be prepared to pay home equity loan closing costs (usually between 2% and 5%).
There are some downsides, however. For example, a home equity loan lender uses your home as collateral, making it risky if you miss payments. Plus, be aware that it may take longer to get your money than other loan products — home equity loans can often take up to 45 days or more to close. Still, you may be able to deduct your interest, since you’re using your equity to fund improvements to your home.
| Pros | Cons |
|---|---|
Fixed interest rate on loan Long repayment terms (up to 30 years) Interest may be tax deductible | Risk of foreclosure if you default High closing costs (potentially 5% of the loan amount) A second lien on your home |
Home equity line of credit (HELOC)
A home equity line of credit (HELOC) lets you turn your home’s value into a revolving line of credit.
The HELOC draw period (usually five to 10 years) is when you can use the line of credit while making interest-only payments. After the draw period is over, you enter the repayment period — at this point, your credit line ends and you are responsible for monthly payments on the balance, like any other loan product.
A HELOC usually has a variable interest rate, meaning your payments will likely fluctuate each month during the repayment period, though fixed-rate loans are possible too.
| Pros | Cons |
|---|---|
Lower interest rates compared with personal loans Low payments during draw period Credit line can be used on a rolling basis | Typically fluctuating interest rates during the repayment period Risk of foreclosure on your home if you miss payments |
Cash-out refinance
A cash-out refinance can leverage your home’s equity to access tax-free money for a basement project. This option works by refinancing your current mortgage over the limit of what you owe and taking out the remainder in cash. You can usually access as much as 80% of your home’s value with this type of product, depending on the loan type. Still, one downside of a cash-out refinance is that you’ll have to sacrifice equity that you may need in the future.
You can use a conventional mortgage, FHA or VA loan with this option. If you use the cash-out refinance for home improvement projects, you may be able to take a tax deduction on the interest payments.
| Pros | Cons |
|---|---|
May be able to deduct interest payments One monthly mortgage payment Use the equity in your home | Potentially longer repayment period Removes equity Risk of losing your home if you default |
FHA 203(k) loan
The Federal Housing Authority (FHA) provides a special renovation mortgage called a FHA 203(k) loan that’s designed to help homebuyers finance upgrades, improvements and repairs. This type of loan is a little more complicated than a conventional refinance.
There are two versions of the 203(k) loan — standard and limited — and the best one to finance a basement remodel will depend on the scope of work. The limited loan lets you borrow up to $35,000 for your renovation, while the standard allows you to spend more (the property’s pre-rehab value plus the rehab cost or 110% of the appraised value post-rehab, whichever is less). However, when you use a standard 203(k) loan, you’ll be paired with an FHA-approved consultant; they’ll serve as your go-between with the contractor for the duration of the renovation, helping with tasks like making payments. You’ll also need to work with an FHA-approved lender with this loan option.
There are a few steps to securing an FHA 203(k) loan — these include providing a copy of your construction plans and allowing an FHA appraiser to determine the value of your finished project. You can use a 203(k) to refinance an existing home, and like most mortgage loans, you may be able to deduct your interest come tax time.
| Pros | Cons |
|---|---|
Interest may be tax deductible Designed specifically for renovations and rehabs Qualify with lower credit scores | Mortgage insurance is required FHA loan limits ($35,000 for limited version) Must meet future appraisal criteria |
Personal loan
If you don’t have enough home equity, or you don’t want to use the equity you do have to fund your renovation, you could consider a personal loan. Usually, these loans have a fixed interest rate and a simple payback schedule. Some lenders offer specific home improvement loans — and, depending on your qualifications (like a good credit score), you may be able to borrow as much as $100,000 for a renovation project.
Still, there are other factors when considering a home equity loan vs. personal loan. A personal loan may get you cash quickly — even within 24 hours — depending on the lender. At the same time, they can also have shorter repayment periods and higher interest rates than cash-out refinances or other mortgage loans. If you think you can repay a personal loan on time, using one could help you keep equity in your home.
| Pros | Cons |
|---|---|
Receive cash fast Won't have to use home as collateral No closing costs | Potentially high interest rates Short repayment terms Could negatively impact your credit if you miss payments |
Contractor financing
Some contractors offer loans via third-party vendors to their customers. Basement finishing financing through your contractor can jump-start your renovation and keep the project under one umbrella. These are usually unsecured loans offering short-term repayment plans.
Unlike a home equity loan or HELOC, an upside to contractor financing is that you likely won’t have to use your home as collateral. Plus, some lenders may offer interest-free loans. These products are convenient for the borrower, but before you agree to one, do your due diligence on your contractor and their third-party lender.
| Pros | Cons |
|---|---|
Only borrow what you need Convenient Fast funding | Short repayment terms Could hurt credit if you miss your loan payments Not offered by all contractors |