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Home Finances Overview

Knowing when to take out a loan for home improvements and knowing which financing options are best for different types of projects can help you make smart decisions when upgrading your home.

Planning home finances David Yellen

Knowing when to take out a loan for home improvements and knowing which financing options are best for different types of projects can help you make smart decisions when upgrading your home. Options include home equity loans, ‑home equity lines of credit, cash-out mortgage refinances, and others. Let’s learn more about these different methods of home improvement financing.

Things to Keep in Mind Before You Borrow

There are a few different things to consider when deciding how to finance a home improvement project. One of the first is how much the project is going to add to your home’s resale value. Unless you’re paying with cash (or perhaps a credit card with a special, limited-time promotional 0% interest rate), you’re going to be paying interest on what you’ve borrowed. Therefore, it’s best to only borrow money to pay for renovations that are going to have a high return on investment (ROI), such as building an addition or remodeling your kitchen or bathroom.

Once you’ve decided to borrow, it’s time to look at your options. For homeowners who’ve paid off enough of their mortgage, borrowing against their home in the form of a home equity loan or a home equity line of credit (HELOC) is usually a great option. What’s the difference? A home equity loan is when you borrow a single lump sum that you repay by making fixed payments over a specific amount of time. A HELOC, on the other hand, is more like a credit card: you can borrow money as you need it, up to a certain amount during a predetermined “draw period” (usually 10 years), after which you pay back only what you borrowed (you might also have the option of paying interest during the draw period as well).

The maximum borrowing amount for a HELOC is set by the lender, and you can use as much or as little of the line or credit as you want; you access the money whenever you need it by writing a check or using a linked debit card, with no additional paperwork needed. While a home equity loan usually has a fixed interest rate, a HELOC has a variable interest rate (again, like a credit card), and often starts off at a lower rate than a home equity loan. In both cases, you borrow money from the bank against the value of your home.

Other Finance Options to Consider

Another option would be a cash-out refinance of your home. During a cash-out refinance, a homeowner takes out a new mortgage that is for a larger amount than the existing mortgage and then takes home the difference in cash. For example, if you owe $300,000 on your home and need to do $25,000 in renovations, you’d refinance for a new mortgage of $325,000 and you’d get $25,000 in cash. Technically, you can use that cash however you want, but given the interest you’re paying, it’s smart to be strategic about how you spend it.

A third option would be to take out a home renovation loan. There are many types of home renovation loans, all of which have different factors to consider: your credit score, your income, the cost of your home, whether you’re doing structural or cosmetic improvements, and even where you live. For example, the USDA offers home renovation loans through its Rural Development program for people who meet income requirements and live in qualified areas.

If you’re doing minor, less-expensive work (maybe repainting your house or installing new doors), another option would be to open a credit card with a promotional, 0% introductory interest rate. For homeowners with good credit who are likely to be approved for these sorts of offers, this provides a way to spread out payments over time without paying additional interest. However, this option requires the borrower be confident they can pay back the balance of the improvement within the promotional, interest-free time frame.

In rare cases, your contractor might also be able to offer you a loan. These are usually done through third-party vendors that your contractor works with and the rates will depend on the usual factors—your credit score, the amount you’re borrowing, your income, etc.

It’s best to speak to potential lenders to better understand your options and make the right choice for your project and finances.

Types of Projects to Finance

You can essentially finance any kind of home improvement project, whether it’s structural or cosmetic. However, a good rule of thumb is to only borrow money to complete renovations that will either save you money in the long run or increase the value of your home. Hanley Wood, a company that keeps data on the construction industry, puts together an annual cost-value report that considers a variety of home repairs and their ROI. Replacing your garage door, installing manufactured stone veneer to your home’s exterior, doing a minor kitchen remodel, or building a deck are all at the top of the 2019’s study in terms of costs recouped. Other high ROI projects include insulating the attic, upgrading appliances, updating the bathroom, and finishing the basement.

If a renovation project likely won’t increase the home’s resale value or save you money (say, on future heating or power bills), it’s best to save up and pay for it with cash. Regardless of what you choose, do your research and look at multiple options to determine the financing method that best fits your needs.

Resources

Looking to learn more about home improvement financing? Here are some resources: