You’ve decided to finally make that home update that you’ve been dreaming of. Whether it’s a bathroom remodel or turning your dusty attic into an office, funding is an important consideration.
Figuring out how to finance a major home improvement project can be a puzzle for homeowners. Paying with cash, of course, is ideal, but what if that’s not an option. Is it smart to borrow money for these jobs when you already have a mortgage?
The answer to this question depends on several factors, which you’ll want to examine closely before making this important financial choice.
Start with a budget
Once you have your wish list of a home remodel projects ready, get quotes from several different contractors so that you can arrive at a budget. If the totals are far above what you originally planned, prioritize the renovations that improve the value of your investment.
Regardless of your final budget, it’s always a good idea to add a cushion of at least 10% to account for surprises. If you plan on doing the work yourself, bump that up to 20% to account for surprises, permit fees, equipment rental, etc.
Now that you have a budget, you can take a look at your financing options.
Home remodel finance options
How much you can borrow, if anything, will depend on several factors. The first is your personal credit rating. The higher your credit score, the more you’ll be able to borrow and at the best rates. Click here to check your credit report and score for free.
Lenders will also consider your income, debt ratios, and the loan-to-value ratio of your home. A lender will look at your total monthly debt as a percentage of your gross monthly income. A ratio below 36 is preferable. The loan-to-value (LTV) ratio shows what ratio of the property’s appraised value is financed by the loan. Lenders prefer an LTV at or below 80% for any mortgage-based loan.
For example, let’s say that your home appraises at $300,000, you owe $200,000 on your mortgage, and you want to add $75,000 in home remodel improvements. 80% of $300,000 is $240,000. Lenders will subtract the mortgage balance, $200,000, from the $240,00 to figure out the maximum that you can borrow. In this case, it’s $40,000. If you need $75,000, you’ll have to find additional sources of cash.
No equity in your home? Read this article to learn how to get a home improvement loan with no equity.
Now that you have your budget and some information about the factors lenders consider, here are your options to finance your home improvement projects:
Pay with cash
If you can pay for your home remodel with cash, this should be your first choice. Paying with cash can help you stay in control of your budget. But, home improvements are expensive, and this option isn’t a realistic one for most people.
Refinance your mortgage
Is your current mortgage interest rate higher than today’s market rates? If so, you might benefit from refinancing your mortgage at the lower rate. This can free up cash from your monthly budget, and you might also be able to tap into home equity through a cash-out refinance. This is a good option if you are lowering your monthly payments and improving the value of your home with a remodel.
Home equity line of credit
If you have built enough equity, a home equity line of credit (HELOC) might be a good option. This is a line of credit that uses your home as collateral.
A HELOC is a good choice if you have extensive remodeling plans that total more than $50,000.
The equity line is usually good for ten years (often renewable) and interest rates are variable, usually prime plus a stated amount. You are limited by your LTV, however, and failing to repay your HELOC could risk foreclosure on your home.
Home equity loan
Another good choice if current mortgage interest rates are favorable and you have equity is a second mortgage or a home equity loan. This is a separate loan that gives you access to the available equity in your home for anything you like, such as remodeling projects.
Interest rates can be variable, your interest rate can go up or down as market interest rates change, or fixed, the interest rate will remain the same throughout the loan. Repayment terms for home equity loans are from five to as long as 30 years. Remember, even if interest rates are higher on a second mortgage, the interest payments are still tax deductible.
The Federal Housing Administration (FHA) has several loan products that you can use to finance a home remodel. You can apply for their 203k loan to refinance your home and add money for repairs to the loan’s balance. The FHA Title 1 loan is a separate loan of up to $25,000 for home improvements, which doesn’t require you to have equity in your home.
When you have contractors visit to provide estimates, they might mention that they provide financing for their work. While contractor financing is an option, it’s usually not the best. These arrangements are often expensive. You and you can probably find a better deal on your own.
Borrow from your 401(k)
Borrowing from your 401(k) is another option that you’re better off leaving as a last resort. Most 401(k)s have a lending option, where you pay back the loan over five years. However, you’re borrowing from your retirement, and the entire balance will be due if you leave your job.
If your remodeling projects are small, you might be able to finance them with low-interest credit cards. In fact, many people prefer to use rewards credit cards for larger materials purchases so that they can collect travel miles or other cash-back bonuses. However, credit cards have rates ranging from 7% to 30% APR, which make it an expensive source of financing.
If you have excellent credit, you may qualify for 0% APR balance transfer cards. These cards provide an introductory period where you don’t pay interest on your balance. Read this article to learn about the best balance transfer cards available. Balance transfer cards with an 0% APR are a good choice if your spending is going to be anywhere from $5,000 to $15,000 and you can repay the balance within the intro rate period.
Personal loans to finance a home remodel are an excellent alternative to tapping into your home’s equity or borrowing from your 401(k). Additionally, personal loans offer choices for borrowers who might not have perfect credit or who don’t yet have equity built up in their home.
Most personal loans are unsecured and can be taken out for longer terms, depending on the lender and several other factors. These are a good option for small to mid-sized remodeling projects, anywhere from $1,000 to $50,000.
Finding the best rates for personal loans
You can find personal loans at nearly any bank or credit union, but these aren’t as easy to get as they were in the past. Traditional lenders have tightened their requirements in the wake of the last recession, all but shutting off this source of credit to most borrowers.
Fortunately, some reputable online lenders have taken their place to fill the gap. Some of these are marketplace lenders that match up borrowers with investors, while others are online banks.
When you research personal loans to finance your home remodel, ask lenders the following questions so that you can get the best rates:
- What is the minimum credit score you require?
- Is there a loan minimum and maximum?
- What is your loan annual percentage rate (APR)?
- What are the payment terms?
- Are there loan origination fees?
- Is there a prepayment penalty?
You should already know your credit score when you shop for loans so that you are looking at the right lenders. If you don’t know your score, you can get it for free here.
If you want to finance a home remodel, give yourself plenty of time to consider your options. Prioritize your ideas, locate the best contractors, and learn more about financing home improvement projects so that you can avoid costly mistakes. SuperMoney makes it easy to check the rates of terms of lenders. It also gives you free access to expert reviews and consumer comments o