Imagining how you're going to enjoy the new comforts of a home renovation after you've been approved for a home equity loan can be relaxing. The expanded living room, bigger bathtub, new game room or whatever else you've been dreaming of can seem like a carefree time that you'll soon be enjoying.

Problems pop up, as they often do with construction projects, and some are out of a homeowner's control. Other potential problems, however, can be dealt with before they happen by thinking ahead before getting approved for a home equity loan or line of credit. Here are six things you don't want to overlook before taking out such a loan for a remodeling project:

1 - Realize you're paying higher interest

A home equity loan is given to the borrower in a lump sum, and the interest is charged on the full amount from the beginning of the loan - which are major differences from a home equity line of credit, also called a HELOC.

Without going into all of the ins and outs of a HELOC, it's worth noting that a home equity loan is repaid at a fixed interest rate that's about 2 percent more than a HELOC. The payment is a fixe amount for a specific number of years, usually 20 to 30 years, for a home equity loan that requires at least 10 percent equity in your home.

With however much money you take upfront with such a loan, it's yours to spend as you'd like. Be smart and put the money aside in preparation for paying contractors who will be doing your home renovations.

2 - Check out the contractor

Along with getting referrals from friends and family, check out a contractor's license with state licensing agencies.

Your loan officer will likely want to check out the contractor you want to hire if you're taking out a home equity loan, though a HELOC won't require as much attention, says Trey Horton, a residential mortgage loan officer at InterLinc Mortgage Services in Birmingham, Alabama.

"They don't have to worry about anything if they take a home equity line of credit out," Horton says. "They can even do the work themselves."

3 - Check the contractor's insurance

After checking out a contractor's referrals and past work, and if they've been sued for shoddy or incomplete work, make sure they have enough general liability and worker compensation insurance.

Minimum requirements differ by state, but make sure it's enough to cover your house if it's destroyed, for example, in an accidental fire caused by the contractor or subcontractor.

At least $500,000 is a good starting point for general liability coverage, and $1 million is good for workers compensation insurance, says Stan Templeton, owner of Majestic Construction and Roofing in Oklahoma City. At the first meeting with the contractor, ask that they have their insurance agent send you a copy of their insurance certificate, Templeton says. If they won't, that's a red flag, he says.

"You don't want people on your property who aren't insured," Templeton says. "They fall down on your front step, they may sue you."

4 - Avoid liens on your property

This may be one area that you'd think would be out of a homeowner's control if subcontractors aren't paid by the general contractor and the subcontractors put a lien against your home for nonpayment - even if you've paid the contractor in full. But there are a few options, if you think about them before renovations begin.

One is to require the contractor to secure a payment bond for subcontractors before the project starts. It's a form of insurance that the contractor won't get back if it's not used, and can add $1,000 or more to the job cost, Templeton says.

Another option is to ask the contractor to set aside funds in an escrow account to pay the subcontractors, which should entice subcontractors to sign a waiver to post a lien. This option is rarely used, Templeton says, because the customer's checkbook is a sort of escrow account that doesn't get paid out until certain work benchmarks are met.

Templeton says he can give customers lien waivers that all of the subcontractors are paid in full at specific milestones and the end of a job.

A performance bond can also be requested by homeowners, requiring the work to be satisfactorily completed according to the contract terms. The bond could increase the cost of the project by 2-5 percent, but the extra expense may be worth the peace of mind, especially on large jobs.

5 - Increase your homeowner's insurance

If the renovations are expected to raise your home's value by 6-12%, it's a good idea to check with your insurer to make sure your improved home is covered in a loss, Horton says.

A family's insurance agent can also determine if the contractors have enough insurance to cover potential losses and if the homeowner's insurance should be increased. Wording in the contract with the contractor may need to be added to ensure that the contractor's insurance is the primary insurance and that they waive the right to file claims against the homeowner and the homeowner's insurance policy.

Whatever extra homeowner's insurance you get, don't wait until after the renovation to increase your coverage. Homes can burn to the ground, for example, during construction work, and extra insurance could help cover such losses.

6 - Add life insurance

Life insurance may be the last thing you're thinking about before you remodel your home, but it's something to consider when adding to the value of your home and taking out a home equity loan. Adding more debt to your life is a good reason to check your life insurance policy and review it to make sure you have enough coverage to repay that loan if you die, says Rick Huard, senior vice president of consumer lending at TD Bank.

Published on October 20, 2014