Looking to renovate? Here's how to borrow affordably.
Though the stay-at-home trend may have kicked off in 2020, a lot of people are continuing to hunker down as 2021 rolls along. If you're one of them, now may be a good time to improve your home -- especially if you're capable of doing the work yourself. But home renovations cost money, and you may not have a ton of it lying around. If that's the case, here are a few financing options to look at.
1. A home equity loan
With a home equity loan, you borrow a lump sum of money and pay it off in regular installments over time. A home equity loan doesn't actually need to be used to cover home renovations -- you can borrow against your home for any purpose. But if you use that loan for home improvements, you'll be eligible to deduct its interest on your taxes if you itemize on your return, so that's a nice little perk to enjoy.
With a home equity loan, you'll generally pay less interest than you would with a personal loan. And qualifying is fairly easy as long as you have enough equity in your home. Generally, you'll need at least 20% equity, which means if your home is worth $200,000, your mortgage balance shouldn't exceed $160,000.
2. A HELOC
A home equity line of credit, or HELOC, is a good financing option if you're not sure how much money you need to borrow for home improvements and want flexibility. With a HELOC, you don't borrow a lump sum as you would with a home equity loan. Rather, you apply for a line of credit you can draw from within a specified time frame -- usually five to 10 years. From there, you simply withdraw money as you need it and pay it back over time.
The only difference is that with a home equity loan, you'll generally enjoy a fixed interest rate and predictable monthly payments. With a HELOC, the interest rate you pay on the sum you borrow may be variable, which means your payments could change -- and increase over time.
Like a home equity loan, HELOCs can be used for any purpose. And if you take out a HELOC for home improvements, the interest you pay on the amount you borrow will be eligible for a tax deduction, just as it is with a home equity loan.
3. A cash-out refinance
When you refinance a mortgage, you swap your existing home loan for a new one with a lower interest rate. With a cash-out refinance, you borrow more than your existing mortgage balance, and the extra money you get can be used for any purpose, like home renovations. For example, if you owe $160,000 on your mortgage but qualify for a $180,000 cash-out refinance, you can borrow up to $20,000 to improve your property, with the first $160,000 going toward your existing loan balance.
The upside of doing a cash-out refinance is that mortgage interest rates are so low today that you'll generally snag a lower rate than you will with a home equity loan or HELOC. Plus, if you use that cash to renovate, you'll get to deduct the interest you pay on your entire refinance. (If you don't use the cash-out portion for renovation purposes, its interest isn't deductible, but your remaining mortgage interest is.)
The only downside to consider is that by taking out a larger mortgage, you put yourself at risk of falling behind on your payments. But then again, the same holds true with a home equity loan or HELOC -- either way, it's more debt you need to repay.
As a homeowner, you have plenty of options for accessing cash for renovation purposes. Compare your choices and see which one makes the most sense for you.
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