Finance 101
May 9, 2023

How to Finance Your Home Renovation

Deciding how to pay for home remodeling can be complicated. It’s easy to get caught up in renovation plans but getting the financing right is just as important. Some lending options will even limit the type of renovations you can pay for. Be sure to understand your options and which is right for your project.

Let’s look at the options for home improvement financing.

Ways to finance home renovations

There are lots of options for home repair loans and home remodeling loans. Types of home improvement financing loans can include personal loans and installment loans, home equity line of credit (HELOC), home equity loans, mortgage refinancing, cash-out refinancing, credit cards, and government loans.

To choose the best option for you, have this information ready:

  • Your credit score
  • Your total project budget
  • The monthly amount you can afford in your budget
  • How much cash you have from saving money (if any)
  • The percent equity you have in your home (the difference between how much your home is worth and how much you owe)
  • How much time you need to be able to pay off the renovation amount
  • How quickly you need the funds

This information will help you choose the best financing for your unique project.

Installment Loans

Installment loans for home improvement may also be called home improvement loans or personal loans. These are unsecured loans, so you don’t need collateral, and you’re not at risk of losing your home if you can’t pay. Personal or installment loans for home improvement are available from banks, credit unions, and online lenders.

Installment loans usually have lower loan amounts, shorter repayment times, and fewer fees than home equity or HELOC loans (see below), but typically have higher interest rates. For this reason, they can be best for small to midsize renovation projects, like bathrooms and kitchens.

Before taking out an installment loan for home improvement or home repair, be sure you compare lenders. Consider interest rates, fees, repayment terms and how quickly the money is available.

As with most loans, your credit score will determine how much you can borrow and the interest rate. There are options for borrowers with lower credit scores, however, repaying an installment loan as promised can also increase your credit score.

Home Equity Line of Credit (HELOC)

A Home Equity Line of Credit (HELOC) may have lower interest rates than a personal loan because it’s a secured loan – it uses your home as collateral. This lowers the risk for the lender.

You can think of a line of credit (LOC) as revolving credit. You can borrow what you need when you need it (up to your borrowing limit), and the amount you pay off can be borrowed from again. This makes a HELOC a good option for large or long-term projects.

You don’t want to put your home at risk, so be sure you understand your loan terms and can make payments on time. Since most HELOC loans have a variable interest rate, your payments could increase over time or with market changes. You’ll also have closing costs to pay with a HELOC (about 2% to 5% of the amount borrowed).

The amount you can borrow for a HELOC will depend on your loan-to-value ratio, or LTV. This is calculated using your credit score, your home’s value, and the outstanding value on your mortgage. You can find calculators online to help estimate your payments.

Home Equity Loan

A home equity loan is sometimes referred to as a second mortgage. It lets you use the equity you have in your home to pay for upgrades. These loans will have a much higher borrowing limit and a longer repayment period than an installment/personal loan.

A home equity loan is a secured loan, so your home is at risk as collateral. Funds are paid to you in one lump sum. A home equity loan has a fixed interest rate and consistent payments over the life of the loan. These loans are best for medium to large projects.

Be aware that you’ll need to bring cash to the table for closing costs on a home equity loan. When considering a home equity loan, you also need to know exactly how much you need to borrow.

Like other loans, your equity in your home and your credit score will affect the loan terms and the amount you can borrow. According to NerdWallet, a home equity loan will allow you to borrow about 85% of your home’s value minus what you owe on your mortgage.

Cash-Out Refinance

With a cash-out refinance, you take out a bigger mortgage with a new interest rate. The new larger loan pays off your current mortgage and leaves you the difference in cash to use for home improvements. The cost of the improvements is part of the new mortgage payment, so there isn’t another payment or loan.

A cash-out refinance may be a good idea for those who can qualify for a lower interest rate than their original mortgage. In these cases, homeowners might be able to drop their monthly mortgage payment even after “cashing out” part of their home’s value for repairs.

Consider a cash-out refinance carefully. Some experts say this option is best for smaller projects and emergency repairs. Others argue a cash-out refinance is a good idea when you need a large loan to renovate a home you plan to stay in long-term. Do your research carefully and decide for yourself.

Keep in mind, it will take you longer to pay off your mortgage, and the total amount you owe will increase. You’ll also need cash for closing costs with a cash-out refinance.

Credit Cards

Credit cards can be one of the most expensive ways to pay for home renovations. But they still have their place.

If you’re buying a new vanity or appliance and plan to pay it off within 30 days, a credit card could be your best option. Some credit cards will offer an introductory 0% interest or cash-back perks you can take advantage of. Generally, credit cards are best for small upgrades and repairs over a short period.

Be sure to understand the terms of your credit card agreement if you’re taking advantage of an introductory, cash-back, or other offer so you don’t get caught paying a high interest rate.

Government Loans

Government loans tend to have lower interest rates and better terms than regular loans. You could also save on costs for interest and insurance. Keep in mind, not all lenders offer these loans. You can search the lender list at Housing and Urban Development for one that lends in your state.

There are several kinds of government loans available. The U.S. Department of Housing and Urban Development (HUD) offers the FHA 203(k) loan, which allows you to include renovation amounts in your mortgage at purchase or refinancing.

HUD also offers Title 1 Property Improvement Loans which can be used to finance a remodel. This loan can pay for home improvements, remodeling or home repairs. This loan allows you to borrow up to $25,000 for a single-family home without having any equity, but does require your home as collateral. Renovations must improve the livability of the home, so some upgrades won’t qualify. You can use a Title 1 PIL on its own or with an FHA 203(k) loan.

The Federal National Mortgage Association (Fannie Mae) offers the HomeStyle Renovation Mortgage, which gives a buyer enough to buy the property and make renovations. With this loan, all contractors must be approved by the lender.

Veterans Affairs offers cash-out refinance loans to take cash equity out of your home. The VA secures these loans. For more information, visit the VA Home Loans (.gov) official website.

Overview

Financing Type May Be Best For ...
Cash (savings)
  • no interest cost
  • nothing to repay
  • definite budget/no risk of overrun
  • flexible timelines
Personal loan/home improvement loan
  • small to midsize projects
  • lower loan amounts
  • fast funding
  • not risking home as collateral
Home equity line of credit (HELOC)
  • longer/bigger projects
  • repeated borrowing over time
  • homes with 15% to 20% equity or more
  • flexible long-term repayment options
  • those with available cash for closing costs
Home equity loan
  • medium to large projects
  • good credit scores
  • predictable payments without fluctuation
  • lump sum payment
  • those with available cash for closing costs
  • secure property values
Cash-out refinance
 
  • a new, potentially lower interest rate
  • getting into a fixed-rate mortgage (from ARM)
  • those with available cash for closing costs
Credit cards
  • small upgrades and repairs
  • possible introductory 0% interest offers
  • cash-back offers if paying off within 30 days
Government loans
  • livability improvements
  • potential for borrowing without equity
  • legitimate lenders
  • long-term tenants may be eligible

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