Some home improvement projects are larger than others and are a big investment in your home. Remodeling your home is well worth the investment, but it can carry a large price tag depending on the project. Large or small, there are many ways to pay for home improvement projects so you can evaluate the best option for your individual situation:
1. Cash or Check
With smaller projects, deposits, or handyman services and your preference, it might make the most sense to pay for your home improvement project with cash or a check. If it’s a project you were considering cash for and would prefer a stronger paper trail and more consumer protection, then a check could be the better option.
Not all contractors accept personal checks, so make sure you check with the contractor you’re partnering with to make sure they accept your preferred form of payment. However, if you haven’t thoroughly looked into a contractor and they are pressuring you to pay with cash, especially upfront, in full, and without paperwork, beware as this is a common home improvement scam to avoid.
2. Credit Card
Another option for paying for projects that you were considering cash or check for is putting it on your credit card. If you are able to pay off the balance soon, it may make sense to use a credit card, especially if there are credit card rewards that make it worthwhile and you are able to pay it off before the interest hits.
If the project is large enough that you will need to make multiple payments and you’ll carry that balance on the credit card, it may not make sense depending on your interest rate. In this case, a loan with a lower interest rate may make more sense.
3. Personal Loan
Although there are specific loans available for home improvement, another option to pay for home improvement projects is to take out a personal loan. Depending on your personal situation and the options available to you, you may be able to get a lower interest rate in an easy and cost-efficient way without borrowing against the equity you have in your home.
4. Home Improvement Loan
A home improvement loan is structured similarly to a personal loan. Unlike personal loans that can usually be used for whatever you want, home improvement loans are marked specifically for home improvement projects.
They tend to have fixed interest rates, quick approval processes, and are generally offered by credit unions, banks, and other lenders. Although the rates can sometimes be a little higher and the repayment periods shorter on these loans than other options, they do not use your home as collateral and there is never a lien on your home with this option.
5. Home Equity Financing Options
There are a few different financing options available when it comes to home equity. All of them borrow against the equity of a home in some way and use the home as collateral in some way, but the details vary between them. Here are a few of the most common home equity financing options:
Home Equity Line of Credit (HELOC)
Home Equity Lines of Credit (HELOCs) are offered by banks, credit unions, and other lenders. This financing option provides a lot of flexibility for home renovations and can be a low-cost borrowing option with lower interest rates than other options.
A HELOC works like a revolving line of credit, like a credit card for your home. There is a maximum amount you can borrow and repayments occur in installations with interest. It is also considered a mortgage product. If this option seems like the best one for you, make sure you look into different lenders for the best interest rates and closing rates.
Something else to consider is that the interest you pay on a HELOC is considered tax-deductible. However, you are borrowing directly against the available equity in your home, which means your home is collateral and the lender can foreclose on your home if you are unable to repay it.
Home Equity Loan
Home equity loans are similar to HELOCs in that they borrow against the equity of your home and your home is used as collateral. Instead of a revolving line of credit where you can borrow what you need as you need it up to your maximum with a HELOC, the entire amount is borrowed up front with a home equity loan and repayments begin immediately.
The amount borrowed is fixed and has a fixed interest rate. The interest rates do tend to be lower than some other loan types, but you will need to shop around and consider your options. Like a HELOC, the interest you pay on a home equity loan is considered tax-deductible.
Generally, the amount you can borrow is similar to a HELOC in that it depends on your credit score, income, and market home value. This option is also considered a mortgage transaction, so there may be additional closing costs to consider.
Another one of the ways to pay for home improvement projects with home equity is cash-out refinancing. With this option, you can refinance your home, get a new mortgage, and receive the difference between the old and new as cash in your bank account.
Essentially, you take out a new mortgage loan that is larger than the amount left on your current mortgage and get cash for a portion of your home’s gained value thus far. This can be a good option if you have built a lot of equity in your home and have good credit. If you are a veteran, there is a VA cash-out refinance option that has added VA benefits.
Generally, this option has an 80% LTV (loan-to-value ratio). This means that your cash-out limit is up to 80% of your home’s value. Depending on your situation, this can result in a lower interest rate and provides the convenience of having renovation costs included in your new mortgage payment.
However, you are limited by the current value of your home, your income, and your credit, and you need to consider how much of your current mortgage is remaining. You will need to go through a full mortgage application and approval to use cash-out financing, so it may not make sense if borrowing conditions are unfavorable.
Keep in mind that your home improvement project costs will be financed in addition to your mortgage over the entire term of the loan. Depending on your situation and current borrowing conditions, there may be other financing options that offer better rates and make more sense long-term.
FHA 203(k) Renovation Loan
An FHA 203(k) Renovation Loan is a financing option that combines home improvement costs and mortgage payments into one new payment. Instead of refinancing and cashing out, the funds borrowed for renovations are held in escrow. Instead of cash you receive and pay to the contractor, the funds are paid out as projects are completed.
An FHA 203(k) allows you to get one loan that combines mortgage and renovations into one payment. Although these loans also tend to have lower down payment and lower credit score requirements, they have more requirements on what qualifies, and it can be difficult to get work approved.
In order to use this financing option, you have to find both an FHA-approved lender and contractors who can get bids in for whatever renovations you want to fund before the loan closes. Specific areas have different FHA mortgage limits that loans cannot exceed and the minimum cost of renovation is usually $5,000.
It is only once the loan closes that renovation work can begin and those funds held in escrow can be used to pay contractors. This requires a lot of planning and scheduling upfront to ensure you have what you need to meet the requirements for the loan and get the timing right.
Fannie Mae HomeStyle Renovation Loan
A Fannie Mae HomeStyle Renovation Loan is similar to an FHA 203(k) in the sense that it creates one loan for the mortgage and renovations. You have to find a mortgage lender that is HomeStyle Renovation approved and there is cancellable mortgage insurance with this option as it is similar to a conventional mortgage.
Similar to an FHA 203(k), work needs to be quoted, approved, and scheduled before the loan closes. It tends to be less flexible than other loan options as solid bids are required and the contractor must meet the timelines required by the loan.
Instead of being held in escrow like an FHA 203(k), the funds for a HomeStyle loan are held in a custodial account. In this case, the LTV (loan-to-value) ratio also takes the project into account. As the contractor completes approved work, they can request funds for payment from the custodial account.
6. Buy Now, Pay Later
More financing options become available through third-party lenders and financing partnerships that offer buy now, pay later options with desirable rates and discounts. Depending on the contractor you work with, they may have a preferred lender or financing option that they can refer to you and help facilitate.
You will want to take into account the deal being offered, interest rates, repayment terms, and all of the details to accurately compare it to your other financing options. If you are confident that you can repay the loan on time, it may make sense to take advantage of some of these special offers.
Depending on the lender and rates, this could be something like 12 months with no interest and no payments for 84 months. Depending on the loan amount and how quickly you can repay it, it may be to your benefit to explore a buy now, pay later financing option that won’t start accruing interest before you repay it.
Remodel Your Home With Zephyr Thomas
There are many ways to pay for home improvement projects and the contractor you partner with may even have financing options available. There are a lot of things to consider and the best way to fund home renovations will vary from person to person.
Getting quotes from reputable contractors you’re considering for your project and comparing home improvement quotes can give you a better idea of what type of investment you might be looking at for a particular project, which can help you decide what financing options are best for you.
If you’re considering getting started on your next home improvement project, contact Zephyr Thomas at 717-399-4708 to start a free quote!