By David McMillin
The list of expenses for a home renovation project can feel overwhelming. But, whether you’re doing it yourself or hiring a contractor to handle the work, you don’t have to spend every dollar in your bank account to cover the costs. Instead, you can explore a range of financing options to help pay for the project now and repay the funds later.
Eight ways to finance a home remodel
1. Home equity loan
A home equity loan allows you to leverage the existing equity you have in your home for any purpose, including to complete home renovations. For example, if your home is worth $350,000, and you have $150,000 remaining on your mortgage, you have $200,000 of equity. You can use that stake in your home as collateral to borrow more money. How much you can borrow varies based on your credit score and your lender’s qualifying requirements.
2. Home equity line of credit (HELOC)
A HELOC is similar to a home equity loan, but it’s a line of credit instead of a fixed loan. Think of it like a credit card: You are approved to use a certain amount, but you only pay financing charges on what you actually borrow. Additionally, the interest rate on a HELOC is usually variable, so depending on how the market moves, the cost to borrow can go up or down.
3. Cash-out refinance
A cash-out refinance replaces your existing mortgage with a new, bigger loan. For example, let’s say you still owe $100,000 on your home, which is valued at $200,000. You could refinance into a $160,000 mortgage (this would maintain an 80 percent loan-to-value ratio, which is a fairly typical requirement from lenders). You would pay off your existing $100,000 debt and have $60,000 left to cover the costs of a renovation. Your new mortgage with new terms, monthly payment, and interest rate has a $160,000 principal.
While you owe more, you’ll be able to pay off your project over an extended period of time — and generally at a lower interest rate compared to other types of financing — and increase the value of your home.
4. FHA 203(k) loan
A 203(k) loan might be a good route to cover renovation costs if you have a lower credit score. These loans are issued by traditional lenders but backed by the Federal Housing Administration (FHA). There are some notable limitations and additional requirements with 203(k) loans, though. For example, if you want to install a swimming pool, you’ll need to find a different form of financing: 203(k) loans can’t be used to pay for “luxury” enhancements.
5. Fannie Mae HomeStyle Renovation loan
Fannie Mae’s HomeStyle Renovation loan functions similarly to a cash-out refinance, but the government backs the new mortgage. With this option, you can borrow money based on 75 percent of the value after your renovation is finished, instead of being restricted by your current home’s value. This is not designed for a do-it-yourself project, though — HomeStyle renovation loans require you to work with a licensed contractor or architect to submit plans for review.
6. Personal loans
A personal loan is another option to pay for a home improvement project, but you don’t run the risk of losing your home if you don’t pay it back. However, some personal loans come with insanely high-interest rates, as much as 36 percent. Take a close look at the math before thinking about this option to avoid paying a hefty amount of interest over the life of the loan.
7. Credit cards
There are plenty of cards with cash-back rewards, 0 percent introductory APR, and attractive sign-up bonuses, which make them good candidates for home improvement expenses. However, putting thousands of dollars on a credit card can be a slippery slope toward debt.
Let’s say you earn an extra $500 sign-up bonus in exchange for spending $5,000 on a new card. Then, you wind up making minimum payments on that $5,000 balance and carrying the debt for two years. That $500 bonus can be overshadowed by compounding interest. If you’re thinking about using a credit card for your home improvement project, make sure you have a strategy to pay off the balance in full immediately.
8. Dipping into your savings
Rather than financing a home improvement project, paying in cash comes with the assurance that you won’t take on more debt. Using cash from your savings account is the cheapest option for paying for a home remodel. However, you need to avoid draining your savings to a dangerously low amount. Make sure you have additional money to help cover overages and, more importantly, to pay for other expenses in your life or emergencies that could arise during the project.
Which financing option is best for you?
How to finance a home renovation starts with estimating how much the entire project will cost. If it’s a small improvement that’ll be under $5,000, there are plenty of options to consider. You could make a budget to save up for the project and cover it without any financing costs, apply for a low-interest personal loan or open a new credit card. If it’s a bigger overhaul that will require a major investment, you’ll want to explore long-term financing plans. Think about these three key questions when evaluating different ways to pay for your project:
- How much equity do you have in your home? Take a look at your current mortgage statement to determine how much you owe on your property. If you’ve paid a substantial amount of your principal down, your loan-to-value ratio is in good shape. That can make a huge difference in how much you can borrow.
- What is the interest rate? It’s not just about how much you can borrow. You also need to understand how much you’ll pay for the privilege. Compare interest rates on a range of loans and estimate the full cost of borrowing. For example, a 14 percent interest rate on a 72-month personal loan will wind up with a steep price tag. Depending on where life takes you, you might not even live in the home at the end of those six years.
- Are other closing costs involved? Borrowing money can require paying money upfront, too. For example, a cash-out refinance comes with all the traditional closing costs of a mortgage, which can be thousands of dollars. Home equity loans also typically come with closing costs, although they’re lower than a full refinance.
Should you renovate or sell your home?
Before spending money on a big upgrade, think about how long you plan to stay in the home. If you have no plans to move any time soon, a major renovation can make a big difference in your quality of life. For example, if you remodel your kitchen and cook in it every night, you’ll be getting plenty of value from your investment.If the price tag of the renovation seems overwhelming, though, you might want to think about selling your home and finding a new one that allows you to skip the hassles and expense of a renovation. Ultimately, you should estimate how much value your renovation would add for a sale. Opendoor’s home improvement value calculator is a good place to start. Get an idea of what your renovation will do for your property’s value so you can make an informed decision about whether to launch the project or launch your home on the market.
This article is also posted on Bankrate here.