by Maurie Backman | April 30, 2021
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Home renovations can be costly. Should you take on debt to finance them, and if so, what type?
Whether it's an outdated master bathroom, a closed-off kitchen with dying appliances, or a playroom that needs a facelift, you may have some renovations you'd like to check off your list. The upside of renovating your home? You can increase its value while also enhancing your quality of life during your time living there. The downside? The cost involved.
Home improvements can be expensive, and if you don't have the money in savings to pay for them, your only choice may be to borrow to finance those projects. But is that a good idea?
Well, it depends. There are certain types of loans that make sense for home renovations -- and other types that don't.
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If you need money to finance a home improvement project, charging it on a credit card isn't usually a good idea. With a credit card, you'll generally pay more interest than you will with another type of loan. Plus, too much credit card debt could hurt your credit score, making it harder to borrow money the next time you need to. And while it may seem like a good idea to finance a home improvement project with a personal loan, since you'll generally pay less interest than you will with a credit card, there may be some better options.
Equity is the amount of your home you own outright, and you can borrow against it for any reason. If you need to finance renovations, a home equity loan could be a good bet. With one of these loans, you'll generally snag a lower interest rate than you will with a personal loan, and home equity loans are fairly easy to qualify for because your home is used as collateral.
That means you run the risk of losing your home if you take out a home equity loan and fall very behind on your payments. (The lender can eventually take your house to get back the money it's owed.) But if you borrow responsibly -- meaning, you only take on a loan you can afford to pay back -- you can mitigate that risk.
With a home equity line of credit, or HELOC, you get a line of credit to draw from as you wish. HELOCs usually give you five to 10 years to take withdrawals, and that flexibility is one reason they may be a better choice for home renovations than home equity loans.
Say you're not sure how much a given project will cost. A HELOC will let you err on the side of it costing more, because you can apply for a higher line of credit and not use it all. And at that point, you'll only have to repay the amount you actually borrowed from your HELOC. As is the case with home equity loans, though, you'll need to make sure you can repay your HELOC, otherwise you'll risk losing your home.
With a home equity loan or HELOC, you don't get a new mortgage. With a cash-out refinance, you do. And while the process of closing on a new mortgage is generally lengthier than finalizing a home equity loan or HELOC, the savings may be worth it.
With a cash-out refinance, you borrow more than your remaining mortgage balance. If you need to renovate, you can use that extra cash to cover your home improvements. Given today's refinance rates, you might pay a lot less interest on a cash-out refinance than on a home equity loan or HELOC. You'll just need to make sure not to borrow too much so your monthly payments remain affordable. But to be clear, a cash-out refinance could help you not only fund your renovations, but also make your remaining mortgage balance less expensive to pay off.
Borrowing money to cover home renovations can be a smart move, because the improvements you make could help you command a higher asking price for your home once the time comes to sell it. Just make sure to borrow smartly so you don't pay more interest than necessary.
Chances are, interest rates won't stay put at multi-decade lows for much longer. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase.
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