10 home-improvement financing tips for your next project
There's no one-size-fits-all way to finance a home improvement project. Here are options that will work in most circumstances.
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- Using cash is the least expensive option for paying for home improvements.
- Borrowing against the equity you have in your home with a loan or line of credit is also cost efficient.
- Unsecured loans will have higher rates, but you won't risk losing your home if you're unable to pay.
There are many reasons you may want to renovate your home. Besides the added value they might bring, home renovations may be necessary to fix safety issues, provide additional comfort, or add space for new living situations.
Any successful home-improvement project starts with a good plan, a key part of which is how much it's going to cost and how you're going to pay for it. As of mid-2022, the average remodel or renovation project was just under $47,000, with most falling in the range of about $18,00 to $77,000, according to data compiled by the digital home-improvement marketplace HomeAdvisor.
Start with the basics
The way you pay for a home-improvement project will depend on your individual situation.
"When financing home improvements or dipping into cash reserves, there is never a one-size-fits-all answer," says J.R. George, senior vice president at Trustco Bank. "There are just too many variables involved to be able to price each method accurately."
Before you begin, George recommends you ask yourself these basic questions:
- How much money do you need and how long will it take to pay that amount back?
- Are current loan interest rates favorable?
- If you have cash reserves, how much are you earning on that cash versus how much it will cost to borrow?
Having answers to these questions can help you figure out which method of paying for home improvements will work best for you.
10 ways to pay for your home-improvement project
1. Save the money and pay cash
Cash is the least expensive way to pay for home improvements. There are no interest charges, origination fees, or repayment periods. A 2021 Bank of America survey found that 62% of homeowners making significant changes to their homes planned to use savings to pay for them.
However, as ideal as this sounds, the large cost of renovations can put this option out of reach when your home needs a lot of repairs or an extensive remodel.
"While this can be an effective way to finance some smaller projects, it might not be feasible for homeowners who are doing big projects such as a complete kitchen makeover," says Franco Terrango, retail sales executive at Bank of America. "Pairing savings with other financing options can give you the funds you need to accomplish your goals."
Pros: No interest costs; no credit check or loan qualification
Cons: Ties up a large amount of money that could be used for other purposes
When it makes sense: When you have the funds to pay in cash and when the scope of your project is smaller
2. Home-improvement loan
A home-improvement loan has a fixed interest rate and doesn't use your home as collateral. Amounts can vary from $3,000 to $100,000. You can find home-improvement loans at banks, credit unions, online lenders, and private lenders. They're structured similarly to personal loans.
"A homeowner is approved based on creditworthiness, like with a credit card," says Vince Passione, founder and CEO of digital-lending platform LendKey. "There's never a lien on their home, and the entire process is almost instant."
Pros: Not secured with your home; quick approval process; fixed interest rates
Cons: Higher interest rates than a home-equity loan or line of credit; shorter repayment period
When it makes sense: If you don't have equity in your home or don't want to use your home to secure the loan
3. Home-equity line of credit
A home-equity line of credit (or HELOC) offers a relatively low-cost borrowing option with a lot of flexibility when it comes to home renovations. It is secured by your home. If you aren't able to repay it, the lending institution can foreclose. Banks, credit unions, and other lending institutions may offer HELOCs.
"As homeowners are accumulating equity at a faster rate, a home equity line of credit lets them borrow against the available equity in the home up to their credit limit," Terrango says. "Additionally, home-equity lines of credit give homeowners the flexibility of a revolving credit line that can be accessed as needed, and it tends to offer more attractive interest rates than other financing options – which will save money in the long run."
How it works: A home equity line of credit works similarly to a revolving line of credit such as a credit card. There's a maximum amount you can borrow, and you make installment payments with interest. Lenders generally won't approve you for more than 85% of your home's value, minus the amount you owe on your mortgage.
Your credit limit will also depend on how much you're able to qualify for. If, for example, the amount that can be borrowed against your home is $140,000, but your income and credit score don't qualify you for that amount, the limit will be lower.
Money from a HELOC can be paid directly to the contractor in the form of a check or debit transaction.
Pros: Low rates; convenient access
Cons: Uses your home as collateral on the loan; may have some closing costs
When it makes sense: If your home has a lot of equity and if you're unsure of what your remodeling costs are going to be
4. Home-equity loan
A home-equity loan is like a HELOC in that your home is used as collateral for the loan. However, with a home-equity loan, the entire amount is borrowed up front, and repayments begin immediately. The interest rates are low and funds can be dispersed at the homeowner's discretion.
The amount that you can borrow depends on your income, credit report, and the market value of your home, but generally follows the same guidelines as a HELOC. The main difference is a homeowner borrows a fixed amount with a fixed interest rate on a home-equity loan. There may also be additional costs.
"Borrowers need to keep in mind when borrowing against your house is that it is a mortgage transaction," George says. "This often results in some form of closing costs which can equate to thousands of dollars."
Pros: Low interest rates; set amount of money financed
Cons: Full amount must be applied for up front; uses home as collateral on your loan; possible closing costs
When it makes sense: If you have a larger renovation with a solid bid from a contractor
5. Cash-out refinancing
If you have a lot of equity in your home, you can use a cash-out refinancing to replace your old mortgage with a new one and receive the difference in your bank account. With a cash-out refinancing, you take out a loan larger than the amount you still owe and receive a portion of your home's gained value in cash.
It's a new mortgage, so you'll qualify based on income and credit history. A cash-out refinancing generally has a maximum loan-to-value (LTV) ratio of 80%, meaning, you can only cash out up to 80% of your home's value.
For example, if you owe $200,000 on your house and it's worth $350,000, you can refinance up to 80% of $350,000, which is $280,000. The $200,000 mortgage is paid off and you're left with $80,000 in cash.
Pros: Costs of renovations wrapped into your new mortgage; lower interest rate
Cons: Renovation financed along with your mortgage over the entire term of loan; full mortgage application and approval process
When it makes sense: If you have a lot of equity and borrowing conditions are favorable for a new mortgage
6. FHA 203(k) renovation loan
An FHA 203(k) loan combines the purchase of a property and needed renovations into one mortgage. Funds for the renovation are placed in escrow and are paid out as projects are completed. The cost of the renovation must be at least $5,000, but not more than the FHA mortgage limit for the area.
Applicants will need to apply through an FHA-approved lender and be able to find contractors who can bid for the work that needs to be completed before the loan closes. Once the loan closes, the work can commence and contractors will be paid with renovation funds held in escrow.
Pros: One loan for both the purchase of a property and the renovation; lower credit score and down payment requirements
Cons: More hoops to jump through to get work approved, scheduled, and paid for
When it makes sense: If you have less income or a lower credit score, or would like to combine the costs of a renovation with the purchase of property
7. Fannie Mae HomeStyle renovation loan
A HomeStyle Renovation loan covers the purchase of a property and renovations. Before the loan closes, the borrower must work with a contractor to submit plans for approval. The LTV ratio is calculated by taking the project into account. As the work is completed, the contractor can request the funds held in a custodial account.
It's similar to an FHA 203(k) loan, but the Fannie Mae program bears the hallmarks of a conventional mortgage, such as cancellable mortgage insurance. You do have to find an approved HomeStyle Renovation mortgage lender.
Pros: Low rates; one loan for both the purchase and renovation of a property
Cons: Not as flexible as other options
When it makes sense: If you want one loan for the purchase and renovation of a property and are able to get a solid bid from a contractor who can meet the timelines required by the loan
8. Government-backed renovation loans
For those who qualify, a government-backed renovation loan could be a low-cost option for a home improvement project. Here are some lesser-known options.
- HUD Title I property improvement. Amounts can be as much as $25,000 with terms as long as 20 years. To qualify, the project must substantially improve the safety and liveability of the property.
- VA cash-out refinance. Terms and conditions are similar to conventional cash-out refinancings but with the added VA benefits, such as lower fees and credit requirements.
- USDA single-family housing repair loans and grants. This program offers loans up to $40,000 to very low-income households in eligible rural areas. Grants are also available for borrowers over age 62. The money can be used to repair, improve, or modernize your home. Loans are for 20 years at a 1% interest rate.
9. Personal loan
Applying for a personal loan is similar to what you would experience with a home-improvement loan. Your home is not used as collateral, so you'll pay a higher rate than you would with a secured loan. But personal loans also have fewer strings attached than other types of home-renovation financing, giving you more flexibility in how you can use the money.
Most banks, credit unions, and other lenders offer personal loans. They will examine your creditworthiness in determining how much you qualify for.
Pros: Doesn't use your home as collateral; often has lower interest rate than a credit card; flexibility in what it's used for
Cons: Shorter repayment period and higher payments than a home equity loan or HELOC; may not qualify for as much as you would with a HELOC or home equity loan
When it makes sense: When you don't have enough equity for a HELOC or home equity loan or do not want to use your home as collateral on a loan
10. Credit card
Using a credit card is one of the most expensive ways to fund home improvements. Nevertheless, Bank of America's survey found 24% of households planned to do so.
While this method is convenient and may make sense with a smaller project, most other options will come with a lower cost. One exception might be a new credit card with an introductory 0% interest rate. If you can pay for the renovations within the introductory time period, the cost will be low. The ability to dispute charges for dissatisfactory work or materials could also be a benefit of using a credit card.
However, with APRs ranging anywhere from 16% to more than 24%, carrying a large amount of debt on a credit card becomes very costly. It also can affect your ability to qualify for other, lower-interest loans. When your credit utilization becomes high due to the amount of renovation charges you're putting on the card, your credit score goes down significantly.
Pros: Easy, no paperwork to have your loan or renovation plans approved; funds immediately available; doesn't use your home as collateral
Cons: High interest rates; may lower your credit score if your credit utilization gets too high
When it makes sense: With smaller projects or projects on a shorter timeline