Home Improvement Financing Options
Home Improvement Financing Options – Home renovations can be expensive. But the good news is that you don’t have to pay out of pocket. Home improvement loans allow you to finance the cost of upgrading and repairing your home.
Specialized rehab loans like the FHA 203(k) mortgage exist specifically to finance home improvement projects. And then there are other mortgages—home equity loans and HELOCs—that can provide cash for home remodeling or any other purpose.
Home Improvement Financing Options
So, what is the best home improvement loan? It depends on your needs. Here’s what you should know.
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A home equity loan (HEL) allows you to borrow against the equity you’ve built up in your home. Your equity is calculated by assessing the value of your home and subtracting the outstanding debt on your existing mortgage loan.
Unlike a cash out refinance, a home equity loan does not pay off your existing mortgage. If you already have a mortgage, you would continue to make your monthly payments while paying your new home loan at the same time.
The home loan is “dispersed as one prepayment. It’s similar to a second mortgage,” says Bruce Ailion, real estate and real estate agent.
With a home loan, your house is used as collateral. This means that lenders can offer lower rates because the loan is secured by the property. A low, fixed interest rate makes a home loan a good option if you need to borrow a large amount.
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Keep in mind that you will most likely pay home loan closing costs, between 2% and 5% of the loan balance. So the amount you borrow is needed to make the extra cost worthwhile.
As an added bonus, “a home equity loan or HELOC can also be tax-free,” says Doug Leever of Tropical Financial Credit Union, member FDIC. “Check with your CPA or tax advisor to be sure.”
A home equity line of credit (HELOC) is another great way to borrow from your home equity without refinancing. A HELOC is similar to a home equity loan, but works more like a credit card. You can borrow from it up to a pre-approved limit, pay it back and borrow from it again.
Another difference between home equity loans and HELOCs is that HELOC interest rates are adjustable; they can rise and fall over the loan period. But interest is due only on your outstanding HELOC balance — the amount you actually borrowed — not on the entire line of credit.
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You can only borrow a portion of the maximum loan amount at any one time, which means your payments and interest will be lower.
A HELOC may be a better option than a home equity loan if you have several lower-cost or longer-term remodeling projects to finance on an ongoing basis.
By the end of the term, “the loan must be fully repaid. Or the HELOC can be converted into an amortizing loan,” says Ailion. “Keep in mind that the lender may be allowed to change the terms during the life of the loan. This can reduce the amount you can borrow if, for example, your credit goes down.”
Still, “HELOCs offer flexibility. You don’t have to withdraw money until you need it. And the credit line is available for up to 10 years,” says Leever.
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Another popular way to get money for a home improvement project is with a cash-out refinance. With this option, you refinance to a new mortgage loan with a higher balance than what you currently owe. Then pay off the existing mortgage and keep the remaining money.
The money you get from a cash-out refinance comes from your equity. It can be used to finance home improvements, although there are no rules that say the payoff funds must be used for this loan purpose. You can just as easily invest your money, use it to consolidate debt, or put a lump sum into your bank account.
A cash-out refinance is usually the best home improvement loan when you can lower your mortgage rate while taking out cash. This only works when the current market rates are below your current rate.
You may also be able to adjust the term length to pay off your home earlier. For example, let’s say you have 20 years left on your 30-year loan. Your payoff refi can be a 15-year loan, meaning you should pay off your home five years early.
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So how do you know if you should use a cash-out refinance? You should compare costs over the life of the loan, including closing costs. This means looking at the total cost of the new loan versus the cost of keeping your current mortgage until the end of its term.
Keep in mind that cash-out refinances have higher closing costs — and they apply to the entire loan amount, not just the cash back. So you’ll probably need to find an interest rate that’s significantly lower than your current one for this strategy to pay off.
With the FHA 203(k) program, you don’t have to apply for two separate loans or pay closing costs twice. Instead, you finance the home purchase and home improvements at the same time when you buy the home.
FHA 203(k) rehab loans are great when you’re buying a fixer-upper and know you’ll need funds for home improvement projects right away. These loans are also backed by the government, which means you’ll get special benefits — like a low down payment and the ability to apply with less-than-perfect credit.
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On the other hand, this type of loan can take longer to close. “FHA 203(k) loans are withdrawable and difficult to get approved,” says Jon Meyer, The Mortgage Reports loan expert and licensed MLO. If you go this route, it’s important to choose a lender and loan officer who are familiar with the 203(k) process and can help you with it.
If you don’t have enough capital to borrow, a personal loan is another way to finance home improvements.
Since a personal loan is unsecured, you won’t be using your home as collateral. This means that these loans can be obtained much faster than HELOCs or home equity lines of credit. In some cases, you may be able to get your loan funds the next business day or even the same day.
Personal loans can have adjustable or fixed rates, but they are usually much higher than a home equity loan or HELOC. However, if you have excellent credit or even just good credit, you can probably get an affordable rate.
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The personal loan repayment period is less flexible, often two to five years. And you’ll likely pay closing costs, too.
Those terms may not sound very favorable. But personal loans are more affordable than HELOCs or home equity loans for some borrowers. If you don’t have much equity in your home to lend, a personal loan may be an option to pay for home renovations.
These loans also make sense for financing emergency home repairs—if your water heater or HVAC system needs to be replaced right away, for example. However, Meyer cautions that personal loans are the “least recommended” option for homeowners.
You can always finance some or all of your remodeling costs with plastic. This is the fastest and easiest financing option for a home improvement project. After all, you won’t even have to fill out a loan application.
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But because home improvements often cost tens of thousands of dollars, you need to get approved for a higher credit line. Or you will have to use two or more credit cards. Plus, you’ll likely be paying interest rates that are much higher than those charged by home improvement loans.
If you must use a credit card to finance renovations, try applying for a card with a 0% introductory annual rate (APR). Some cards offer up to 18 months to pay back the balance at that introductory rate. This approach is only worthwhile if you can pay off your debt within
that repayment period.
Like personal loans, credit cards can be acceptable in an emergency. But you shouldn’t use them for long-term financing. Even if you have to use credit cards as a temporary solution, you can get a secured loan to pay off the cards later.
The best home improvement loan will suit your specific needs and your unique situation. So let’s narrow down your options with a few questions.
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If so, you can access the lowest rates by borrowing against the equity in your home with a cash-out refinance, home equity loan, or home equity line of credit.
If so, check out the FHA 203(k) program. This is the only loan on our list that ties home improvement costs to your home purchase loan. Just be sure to review the guidelines with your loan officer to make sure you understand the disbursement rules.
Taking out just one mortgage to cover both needs will save you money on closing costs and is ultimately a simpler process.
“The only time I would recommend the FHA203(k) program is when you’re buying a fixer-upper,” says Meyer. “But I would still advise homeowners to investigate others
Financing Options For Your Home Improvement Project
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