Do you dream about improving your home? In the U.S., the average cost to remodel multiple rooms of a home is $37,910, according to Homeadvisor Thinking of putting in a new bathroom? That’s an average $42,233. Kitchen remodel? Budget up to $60,000. Dreaming is free, but home improvement financing sure isn’t. Find out how you can finance your next home improvement project.
As you can see, the costs can add up quickly. If you don’t have the cash on hand, you will need to find a financing solution that suits your current situation.
The good news is you have plenty of options. However, finding the right fit requires doing a little homework.
Whether you have equity, no equity, good credit, or bad credit, this guide will break down the different paths available and the pros and cons of each option.
Home improvement financing for homeowners with equity
Let’s start with the homeowners who have equity in their homes. You can borrow against the equity to access the money for your project. Casey Fleming, Author of The Loan Guide, says, “There are three basic ways to finance home improvements, and each has its own advantages and risks.”
Your options are:
- Home equity line of credit (HELOC)
- Home equity loan
- Cash-out refinance
A HELOC is a credit line, like a credit card, which is secured by the equity you have in your home.
Fleming says, “You can only borrow a percentage of your current value – usually 90%.” For example, if you have $100,000 in equity and a lender allows for 90% loan-to-value, you can get a credit line up to $90,000.
HELOC’s have two phases, which are the draw phase and the repayment phase. During the draw phase, you can withdraw the money as needed (i.e., as milestones of the improvement project are completed).
You typically only have to make a small minimum monthly payment that covers the interest. When the draw phase ends, the repayment period will begin. The monthly payment will increase to cover the interest and principal, and you will need to repay the amount in full over a set period.
With this route, you can access the cash as you need it instead of getting a lump sum, and you only pay interest on what you withdraw. There are typically no closing costs, interest paid is tax-deductible, and there are no fees for withdrawing cash.
Interest rates are lower than with personal loans or credit cards because the credit line is secured by your home, but they will vary based on on your credit. MyFICO states, as of September 2017, borrowers with a credit score from 620 to 639 would get an 11.393% interest rate on a HELOC, while those with 740 to 850 would get 5.393%.
Look out for hidden fees such as those for prepayment and beware, if you default, your home will be at risk of foreclosure. Also, know that most interest rates are usually variable for HELOC’s, which means your payment can fluctuate.
Home equity loan
A home equity loan (also known as a second mortgage) is a loan secured by the equity in your home. Fleming says you are usually allowed to take out 90% of your equity.
Unlike the HELOC, you get the amount in a lump sum, which means you pay interest on the full amount from day one. Interest rates are lower than unsecured borrowing due to the home being used as collateral and the interest paid is tax-deductible.
MyFICO states, as of September 2017, borrowers with a credit score from 620 to 639 would get a 10.353% interest rate on a 15-year home equity loan, while those with 740 to 850 would get 6.028% rate.
Beyond interest, there will also be closing costs and other fees, which can make this option more expensive than a HELOC at the start.
Thirdly, a cash-out refinance pays off an existing mortgage and takes out a new loan for a higher amount, making cash available for withdrawal. There are limits to how much of your equity you can use; Fleming says, “Typically, 85%.”
The new mortgage will have closing costs and fees, which can make it more expensive at the outstart than a HELOC and a home equity loan. However, it gets you the money for your home improvements without adding a second loan payment.
Instead, you have the convenience of continuing with a single loan, albeit, with a higher payment amount.
The interest rates going this route will still be low because the house is used as collateral, and will generally be lower than rates given on second mortgages.
“They can be fixed, or fixed for a period (3, 5, 7 or 10 years) and then variable,” says Fleming. Additionally, interest paid will be tax-deductible.
On the down side, you will want to consider that mortgage insurance is required if you borrow more than 80% of your home’s value. Further, be sure you can afford the payments because, if you default, your home will be at risk for foreclosure.
Home improvement financing for homeowners with no equity
What if you don’t have equity in your home? Not to worry, you still have options and can look into the following:
- Personal loan or line of credit
- Credit cards
Personal loan or line of credit
Personal loans and lines of credit are convenient, unsecured home improvement loan options. Nowadays, there are dozens of online lenders that you can apply with in a matter of minutes, and without hurting your credit score.
If you are approved, you can potentially have the funds in your account within days (sometimes even one day). If you apply for a loan and are approved, you will be able to borrow a set amount and will repay it (plus interest) over a set term.
Often, these come with origination fees due at the outset. The line of credit is extended to you, and you can use it as needed (like a HELOC). Monthly repayments will be made to the principal and interest.
The downside compared to borrowing against home equity is that the eligibility requirements can be more strict and the interest rates higher. Rates can range from about 2% to 35%. These are higher rates because the loans are unsecured.
To get the best rates, you will need excellent credit. However, the rates are still often lower than credits cards.
With SuperMoney’s loan offer engine, you can get quotes from multiple lenders within minutes with no impact to your credit score.
Credit cards are another option to consider, namely cards with a 0% interest introductory period. Often, these promotional periods range from 12 to 24 months.
The pros here are that you can borrow and don’t have to pay any interest on that loan for the duration of the introductory period. However, after the period ends, you will be assigned a normal interest rate.
Being so, this is a good solution if you can repay the amount borrowed before the introductory period ends.
If you can’t, it still may be an option to consider as you may be able to transfer the balance to another card with a promotional interest-free period, or refinance it using a personal loan with a lower interest rate.
Home improvement loans with bad credit and no equity
If you have no equity and your credit isn’t so great, here are the options you should check out:
- FHA Title 1 Program
- A FHA 203(k)
FHA Title I property improvement loan program
The U.S. Department of Housing and Urban Development (HUD) and Federal Housing Administration (FHA) offer the Title I Home and Property Improvement Loans program. Approved Title I lenders extend home improvement loans insured by HUD.
Owners of single family homes can use the loan to improve the site of the home, make repairs, or make alterations. The maximum loan amount is $25,000, and the maximum loan term is 20 years.
Interest rates are fixed and are based on the common market rate in a particular area. They can vary between lenders and based on your credit score and income.
Loans under $7,500 are unsecured, while those over $7,500 are secured by the mortgage. The home must be completed and occupied for 90 days to qualify.
The pros of this option include that you don’t need to have any equity in your home, you won’t need any collateral if your loan is less than $7,500, you don’t need great credit, and interest rates are often relatively low.
The downsides? For one, there are restrictions on how you can use the loan. Luxurious upgrades like a hot tub or swimming pool are not permitted. Even adding additional rooms, painting walls, or replacing cabinets wouldn’t be approved.
Improvements must “improve or protect the functionality or livability of the home.” Examples would be repairing the roof or fixing structural damages to the home.
Secondly, if you borrow over $7,500 and default, your house will be on the line. Third, the application process can be a bit tedious and take longer than alternative options.
Title I loans are often utilized by investors, homeowners with credit issues, and first-time home buyers.
FHA 203(k) rehab mortgage insurance
“The 203k Rehab Loan is designed for individuals seeking to purchase real estate that requires extensive repairs. This is a subcategory of the FHA Mortgage. One benefit of this type of financing is that you can combine the cost of the property, as well as the home improvement expenses, into one loan,” says Rhett M. Struve, Realtor for Keller Williams Premier Realty.
He adds, “As with the FHA Mortgage, the 203k Rehab Loan requires insurance to protect lenders from mortgage defaults, and interest rates are typically higher than conventional loans.”
In addition to being available to new home buyers, the FHA 203(k) is also available to existing homeowners who want to rehab their homes. They can refinance their existing mortgage and include the improvement costs in a new single mortgage.
The loans are long-term with fixed or adjustable interest rates. Requirements include that the home must be at least one-year-old, improvements must cost at least $5,000, and the total value of the property must fall within the FHA mortgage limit for the area.
Further, there are restrictions on the types of improvements allowed. The eligibility restrictions for this loan make it easier for lower income borrowers to get approved.
However, fees such as those for origination, appraisals, and preparation of architectural documents may be charged. To apply, you will need to find an eligible FHA lender in your area.
Finance your home improvement projects
Now you know the options available for different situations. From borrowing against your home equity to leaning on your credit for unsecured loans to government-back programs, there is a solution for most scenarios.
To find out what home improvement loan rates for which you qualify, identify the best option for your situation, find lenders that serve your area, compare their offerings, and go ahead with the best deal.
Then, you can break ground and start improving your home!
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.