9 Ways to Finance Home Improvements

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:

• Banks, credit unions, and credit card issuers.
• Government-insured or subsidized loans.
• Yourself – more specifically, your retirement savings
  

Banks and other lenders such as credit unions or mortgage lenders offer several different ways to borrow money. Understanding these options will help you make the best decision for you:

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 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:

• Know how much money you need – and how much you can get – from the start.¹³
• Don’t pursue any home renovation project if it doesn’t make financial sense.¹⁴ For example, if you’re counting on making back your investment when you sell (you can’t depend on it), you end up owing more than your house is worth, or your renovated house would be worth way more than comparable homes in your area.¹⁵