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10 Things to Know About Financing a Home Renovation

By Maurie Backman - Mar 3, 2022 at 7:00AM
Couple envisioning their finished kitchen remodel.

10 Things to Know About Financing a Home Renovation

Get ready to transform your space

There are plenty of good reasons to renovate your home. For one thing, you might make your living space more comfortable. You also might add a fair amount of resale value. But if you can't pay for your improvements outright, you may need to resort to financing. Here are some things to know about that process.

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1. It's important to set a borrowing limit before you start

Getting in over your head on the renovation front could cause a true financial crunch. Before you start renovating, set a budget and limit so that you don't wind up over-borrowing -- and falling behind on your payments.

ALSO READ: Will Home Renovations Get Less Expensive in 2022?

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Person takes notes while sitting at table at home.

2. You should pad your budget in case the work costs more than expected

Hidden costs can pop up frequently when you're doing a major renovation. That's why you should assume going into your project that it will wind up costing more than anticipated. If you're asking for a loan to finance a $20,000 renovation, you may want to err on the side of borrowing $25,000 just in case.

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Loan agreement with pen and calculator.

3. You can take out a personal loan to finance your project

If you don't have a lot of equity in your home, you can take out a personal loan and use the proceeds to finance your renovation. A personal loan allows you to borrow money for any purpose, so you don't even need to commit to one specific improvement project over another.

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A person working on a laptop and a calculator next to a small model of a home sitting on the desk.

4. A home equity loan might be a cheaper borrowing option

While a personal loan can be a reasonable borrowing choice when renovating, a home equity loan might result in a lower interest rate on the sum you borrow.

Personal loans are unsecured, so they're not tied to a specific asset. With a home equity loan, the sum you borrow is tied to your own property. There's a little less risk in that regard for your lender, so you may be rewarded in the form of a lower interest rate.

ALSO READ: Should You Get a Home Equity Loan in 2022?

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Home equity line of credit documents on a table.

5. A HELOC could give you more flexibility

With a home equity line of credit (HELOC), you don't borrow a lump sum like you would with a personal or home equity loan. Instead, you get access to a line of credit you can draw from as needed. We talked about how home renovations can cost more than anticipated. In that regard, a HELOC may be your better bet.

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6. You can take cash out of your home to pay for improvements

If you have a lot of home equity, a cash-out refinance could be your ticket to paying for renovations. If you go this route, you'll borrow more than your existing mortgage balance and will get the excess in cash to use as you please.

That said, you could end up paying hefty closing costs on a cash-out refinance, so you'll need to make sure it's worth those fees, especially in light of rising refinance rates.

ALSO READ: Should You Do a Cash-Out Refinance in 2022?

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A stressed-out couple sits in front of a laptop computer.

7. Borrowing against your home equity carries risk

Falling behind on any loan could damage your credit severely. But if you fall behind on home equity loan or HELOC payments, you could risk losing your home. The same holds true if you do a cash-out refinance but don't keep up with your new mortgage payments.

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Stack of credit cards on table covered with bills.

8. Credit cards are a poor choice for financing renovations

If you have a generous spending limit on your credit cards, you may be tempted to charge your renovations and pay them off over time. But that could mean spending a lot more money on interest. Plus, carrying too high a credit card balance could damage your credit score, making it harder to borrow money the next time you need it.

ALSO READ: 4 Credit Card Rules You Should Never Break

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Credit score options, excellent, good, and fair.

9. Boosting your credit score could make borrowing more affordable

Your credit score will play a big role in the interest rate you get on a personal loan or cash-out refinance. It will also play a role, albeit perhaps a smaller one, in securing a home equity loan or HELOC. If your score could use work, you may want to postpone your renovations until it's in better shape.

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10. The more work you do yourself, the less you might need to borrow

You may not have the time or skills to tackle your next renovation project yourself. But the more hands-on work you can do, the less you might pay a contractor. The result? More savings and less money you have to borrow.

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What's the right choice for you?

Clearly, when it comes to financing home improvements, you have options. Consider your choices carefully so that you wind up with the most affordable means of paying to renovate your property.

The Motley Fool has a disclosure policy.

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