24% of Homeowners Could Make This Mistake When Financing Home Renovations

Looking to improve your home? Be careful about how you finance it.

There are plenty of good reasons to renovate a home. Doing so might make your living space more comfortable, which could greatly improve your quality of life. Also, home renovations can lead to higher resale value, so you might get back some, if not all, of the money you put in.

There are plenty of cost-effective ways to finance home renovations. But according to Bank of America's 2021 Homebuyer Insights Report, 24% of homeowners intend to charge their home improvements on a credit card. And that could be a very poor choice that backfires.

The dangers of charging renovations on a credit card

If you have a credit card with a generous spending limit, you may be inclined to charge your home improvement projects since you already have access to that credit line. But credit cards commonly charge more interest than any other loan type. So if you use your credit card to finance home renovations, it could cost you a lot more money than you really need to spend.

Another issue is that carrying too high a credit card balance could damage your credit score. If that happens, it becomes more difficult for you to borrow money affordably when you need to.

A better way to finance renovations

If you're going to renovate, it's best to do so in a manner that doesn't hurt you financially. In the above report, 62% of homeowners said they plan to tap their savings to pay for renovations. That's not a bad idea if you have the money and can leave yourself enough cash to cover three to six months of essential bills.

Meanwhile, 32% of homeowners plan to finance their renovations with a home equity line of credit (HELOC). And that's not a bad choice. With a HELOC, you get access to an amount you can draw from within a preset time (usually 5 to 10 years). If you don't need your whole line of credit to fund your renovations, you can leave the rest of that money alone -- and rack up interest only on a lower sum.

You generally pay much lower interest on a HELOC than on a credit card. And while HELOC interest rates can vary, leaving you with less predictable monthly payments, credit card interest rates can also vary.

Another option you might consider for financing home renovations is a cash-out refinance. This means you borrow more than your remaining mortgage balance and use the extra money to pay for home improvements. Because today's refinance rates are so low, this could be your most cost-effective option.

Renovating a home can be rewarding, but it's important to be strategic in how you pay for those home improvements. If you can afford your next project by tapping your savings, go for it, as long as you leave yourself a cushion to cover emergencies. Otherwise, it pays to look at a HELOC or a cash-out refinance before you whip out a credit card.