Funding a home remodel doesn’t have to be an exercise in frustration if you plan accordingly and consider all of your loan options. It’s important to note that when you make home improvements it may increase the value of your home, which can provide additional equity. Not all renovation projects will increase your home’s value, but some projects that typically boost equity are updates such as a bathroom addition or remodel, new wood deck, entry door or garage door replacement, new windows or a minor kitchen remodel, according to the 2018 Remodeling Cost vs. Value Report.
How to finance home improvements
Whether you’re a new homeowner or have lived in your home for years, home remodels are a part of your homeownership journey. Home improvements can help you live better or more comfortably or help you take care of a repair before it causes more damage or expense.
A home will always need some type of improvement, but how will you pay for it? There are many options to finance a home renovation, but the first step before you look into a home remodel loan is to figure out what you want and how much it will cost.
Plan for your home renovation
Before you begin looking into the best ways to finance your home improvement, start by deciding what you need to renovate in your home—determine the most important project and how much you need to take it on. Next, do your research and call some contractors or go to home improvement stores to get some quotes. Once you have a ball park estimate of the costs, you can determine how much you’ll need to pay for it. Look at your savings and consider what you may need to borrow to finance your home renovation. If you decide you need to take out a home remodel loan, think also about how you will repay the loan and how much you can afford each month.
Ask yourself the following questions:
- Can I do the project myself or do I need a contractor? You can save money by doing all or even some of the work yourself.
- Do I need money one time or do I need access to credit for a longer period of time? Determine if you have multiple projects or just a one-time renovation.
- Can the extra payments fit within my budget? Determine how much you can afford to borrow and for how long.
- How much do I have saved and how much equity do I have in my home? Look at your total financial picture including your expenses and savings.
- Do I want to stay in my home? Whether you plan on staying for a while or want to sell within five years will help you determine how much to invest in the home.
These questions will help guide you to various home renovation financing options.
Best ways to finance home improvements
Here are three options for funding your home improvement project. Consider the advantages and disadvantages of each to help guide you on which is right for your home renovation.
Home Equity Line of Credit (HELOC)
One option for a home remodel loan is a HELOC, which is a line of credit where a borrower gets credit they can draw from. The amount of credit depends on how much equity you have in your home, but your home is used as collateral, so you don’t want to default. HELOCs generally have an adjustable rate. The first few years are the draw phase where you only pay interest, but after that time, the payments include interest and principal, which will increase your monthly expenses. Learn more about HELOCs.
- Potential lower initial interest rates
- Get a line of credit to take out what you need
- Interest-only payments during the initial draw period
- Reduces the equity in your home
- Can risk foreclosure since your home is used as collateral
- You are extending your payments and could pay more in interest over time
- Additional monthly bill on top of your mortgage payment
Cash out refinance
Using a cash out refinance for your home renovation financing refinances your existing mortgage, and allows you to borrow more than you owe to take out in cash. A cash out refinance gives you a lump sum of money to use how you wish. Since it gets rolled into your mortgage, you don’t have to worry about an additional payment, but your mortgage payment will increase depending on the interest rate and how much you borrow.
Cash out refinance advantages
- One loan and one monthly payment
- Fixed interest rate
- Can reduce your current interest rate or change your mortgage term
Cash out refinance disadvantages
- Closing costs will be added
- Your monthly mortgage payment may increase
- It will take longer to pay off your mortgage if you don’t reduce your term
Home equity loan
A home equity loan is a second loan where you can use your home’s equity to take out money in a lump sum for things like a home improvement project. Like a HELOC, your home is used as collateral. Home equity loans have fixed interest rates, so you don’t have to worry about an increase in payment in the future like a HELOC. Learn more about the differences between a HELOC, cash out refinance and home equity loan.
Home equity loan advantages
- Can take out a larger amount than a personal loan
- Interest may be tax deductible, consult a tax professional
Home equity loan disadvantages
- Need to pay a second loan on top of your mortgage
- Since your home is used as collateral, you risk foreclosure if you don’t pay on time
- You reduce the equity in your home that you have built up
Applying for a home remodel loan
Before you apply, it’s important to find out how much you need to take out to pay for your project. You should have a few quotes from contractors and a general budget. This will help you determine how much you need to take out. Also consider how much you can afford. You don’t want to risk your home for an improvement that will cause financial strain.
Apply before renovation begins
Don’t start any work until you secure your funds. You want to ensure you are approved and you get the money you need before any renovation work begins. Paperwork and closing may take longer than expected and put you in a financial bind if contractors need some payment upfront.
Ensure you will get approved for the loan before you start work. Keep in mind these qualifications which lenders will look at to ensure you can pay the debt you take out.
- A good credit score. Lenders are less likely to approve a loan if your credit score is too low and interest rates will be higher for lower credit scores.
- Loan-to-value ratio. You generally want a low loan-to-value ratio, which takes into account how much you owe compared to how much you own of the home.
- Debt-to-income ratio. To determine your debt-to-income ratio you take your current monthly debts divided by your monthly gross income. Financial institutions are less likely to approve a loan if you have too many debts that you may not be able to afford.
If you’re ready to explore your home improvement options, contact Freedom Mortgage to help guide you through all your home renovation financing needs.