By Allan Halcrow | American Express Credit Intel Freelance Contributor
6 Min Read | July 31, 2020 in Life
When making improvements to your home, paying with cash can sometimes earn you a discount.
But if you need to borrow money, researching your options usually is useful. The right approach for you can save you money and reduce long-term financial stress.
It’s important to know how much you need – and can get – before deciding to move forward with your home improvement project.
Choosing the best way to finance home improvements can be as important to a project’s success as choosing the right contractor or materials. People often have numerous financing options to choose from, each of which has pros and cons depending on the scope of your project, value of your home, and your overall financial health. Because of that complexity, experts agree you should spend time researching your options.
Experts also say that if you can afford it, you should use cash to finance any home improvement project. It’s faster and cheaper than other financing options: It eliminates debt, interest charges, and fees.1 But using cash isn’t always possible, particularly for larger projects like a kitchen remodel or room addition.
If you need to borrow money to finance a home improvement project, you generally have three potential sources:
Finding a personal loan, which might be marketed as a home improvement loan, is generally easy and can be a good option for midsize projects like replacing your windows. Personal loans for home improvements require no collateral, and your credit score determines your interest rate. The better your score, the better your interest rate, and vice-versa. Experts suggest that you look for lower interest rates and fees as well as easier re-payment terms.2
A home equity line of credit, or HELOC, is a form of revolving credit, like a credit card. You borrow within the credit line you’ve been granted, and as you pay down what you owe you can borrow more – hence the “revolving” part. This can be a good option for long-term or recurring home improvements. Interest rates are typically much lower than those for personal loans because HELOCs are secured loans with your home acting as collateral. HELOCs also are usually structured so that you can draw from your line of credit for a set period, typically 10 years, followed by a repayment period, typically 20 years. Your payment may increase during the repayment period since HELOCs are usually adjustable-rate loans.3 A HELOC is a home improvement financing option only if you have enough equity in your home – 20% or more.4 To better understand homeowner equity, read “How Much of a Down Payment Do You Need to Buy a House?”
Like HELOCs, home equity loans use your home as collateral and, in exchange, offer lower interest rates. But there are some key differences. A home equity loan is an installment loan, meaning that it’s for a fixed amount and is repaid on a fixed monthly schedule for an established term, typically 10–15 years. Expect to pay closing costs of about 2–5% and other fees for these loans, sometimes called second mortgages. Some home equity loans also carry pre-payment penalties. The good news is that the interest you pay may be tax deductible.
An alternative to getting a second mortgage is to refinance your original mortgage. To obtain the needed funds for home improvements, you take out a new mortgage that is larger than what you still owe on the original, and keep the difference. Keep in mind that you’re using your home as collateral for the extra funds. And you’ll likely pay closing costs and fees. Experts advise that you only pursue this option if you can secure an interest rate lower than the rate on your existing mortgage.5
Some credit cards offer an introductory period in which you pay no interest. A 0% APR credit card can be a good option for a smaller project because it’s possible to borrow the money for free. But experts advise that you only pursue this option if you’re confident you can pay it off before the 0% period expires. Credit card interest rates figure to be higher than other loan options. Your credit score plays a part in whether you qualify for a zero-interest card.
Some government lending programs are designed to help with home improvements. These include:
The U.S. Department of Housing and Urban Development (HUD) insures home improvement loans made by private lenders so that they can make loans they might otherwise consider too risky.6 HUD Title 1 loans allow you to borrow as much as $25,000, even if you don’t have equity in your home. That makes the loans appealing if you recently bought your house and need to make some improvements. Loan funds must be used to improve the livability of your home, so some improvements classified as luxuries may not qualify.7 Note that your application will be denied if your debt-to-income ratio exceeds 45%.8
If you bought a fixer-upper, an FHA 203(k) loan may be a good fit. In this program HUD insures a loan that combines your purchase price with renovation costs, then puts the renovation funds into a special account to use as an improvement project proceeds.9 That can help prevent contractual or financial missteps. Home improvements must be completed within six months. Here, it’s even more important to know the cost of renovations in advance so that you borrow sufficient funds.10
Some counties and municipalities have programs to subsidize some or all of the interest on loans between $25,000 and $50,000 that you get to fund home improvement projects. The goal is to help shore up local property values. These programs can save you money, but as with other government programs luxury improvements are typically excluded. Experts point out that these programs are often burdened by red tape, including monitoring of your project.11
You can borrow half the savings in your 401(k) retirement plan up to $50,000, and then repay it over five years. But this option carries risks. For one, some plans won’t let you add new contributions while you owe a balance against it. If you take a long time to repay yourself, it may significantly impact your retirement fund. And if you leave your job before the loan is repaid, you must pay back the loan within a few months or pay taxes and penalties.12
Experts suggest you keep two principles in mind as you evaluate ways to finance home improvements:
Cash is king when it comes to home improvement. But if you need to borrow money, you have numerous options to finance a home improvement project. Let the scope of your project and your overall financial situation help determine which choice fits best.
1 “5 Best Ways to Pay for Your Home Remodel Project,” The Spruce
2 “How to Pay for Home Improvements,” Bankrate.com
3 “How to Finance a Home Renovation,” Interest.com
4 “How to Finance a Home Improvement Project,” Consumer Reports
5 “How to Pay for Home Improvements,” Bankrate.com
6 “About Title 1 Property Improvement Loans,” Department of Housing and Urban Development
7 “How to Pay for Home Improvements,” Bankrate.com
8 “How to Finance a Home Renovation,” Interest.com
9 “203(k) Rehab Mortgage Insurance,” Department of Housing and Urban Development
10 “How to Finance a Home Renovation,” Interest.com
11 “5 Best Ways to Pay for Your Home Remodel Project,” The Spruce
12 “Home Remodeling: How to Finance Your Project,” TheMortgageReports.com
13 “Here's How to Finance Your Remodel,” ThisOldHouse.com
14 “How to Finance a Home Improvement Project,” Consumer Reports
15 “What's the Best Way to Finance My Home Improvement Projects?,” Lifehacker.com