How to Finance Home Renovations

If your home is your castle, but your castle can use a little sprucing up, you may be looking for ways to pay for the updates.

Should you take out a home improvement loan, refinance using a renovation mortgage, or is there another kind of renovation loan that will work? Should you borrow the money at all, or would it be better for you to pay cash for a home renovation project?

As a homeowner, it seems there are always decisions to make, even when it comes to deciding whether a home renovation loan is your best move. Here, we've outlined everything you need to know about renovation financing.

Financing home renovations

Whether you're turning a dank old basement into a home theater, installing a new pool, or creating a kitchen a chef would be glad to call their own, a home renovation allows you to put your personal stamp on how your castle looks and functions.

Wondering how to pay for home renovations? Fortunately, there are plenty of options for financing home renovations.

Ways to finance home renovations

Home remodel financing doesn't have to be complicated. If paying cash is not in the cards, here are some of the ways you can finance home renovations:

• Personal loan
• Home equity line of credit (HELOC)
• Home equity loan
• Mortgage refinance
• Credit cards
• Government loans

Personal loan

A personal loan could be the best way to finance home improvements if you're looking for something low risk. (Lenders can't repossess your home if you fail to make payments on an unsecured loan.)

The best personal loans are available for up to $100,000 at:

• Banks
• Credit unions
• Online lenders

Highly-qualified borrowers can often snag a low interest rate. And repaying a personal loan as promised will strengthen your credit score.

Home equity line of credit (HELOC)

A HELOC often has a lower interest rate than other types of loans because it uses your home as collateral. If you borrow and repay any portion of the money, you are free to withdraw it again later. You can withdraw funds from a HELOC for 10 years, and have 20 years to repay.

If you miss payments, the lender has a legal right to repossess the property to recoup their losses. Paying for home renovations should never put your home at risk. Before relying on a HELOC, make sure you understand the terms of your loan -- and can make payments on time. Whether you get your HELOC from a bank or credit union, you'll typically pay 2% to 5% of the amount borrowed in closing costs.

Home equity loan

Home equity loans are another way to go about financing a remodel. Unlike a HELOC, home equity loans are distributed in one lump sum, and normally repaid over five to 30 years. Sometimes referred to as a "second mortgage," a home equity loan allows you to use the equity you already have in your home to pay for upgrades. Depending on when you took out your original home loan, a home equity loan may carry a higher interest rate, but it is still a viable loan option. Like a HELOC, a home equity line of credit is likely to include closing costs of 2% to 5% of the amount borrowed.

Refinance

Refinancing your home involves taking out a new mortgage to pay off the old one. Depending on how much equity you have in your home, it is possible to "cash out" a portion of the equity when you refinance. This is referred to as a cash-out refinance.

For example, let's say your home is worth $300,000, and you owe $100,000 on your current mortgage. You refinance $150,000. In this scenario, $100,000 pays off the old mortgage, and $50,000 goes towards financing home renovations.

If your new refinance rate is much lower than your original interest rate, this method has another benefit. It's possible that your monthly mortgage payment can drop even if you "cash out" some of your equity. For some people, paying for home renovations through a cash-out refinance is a great way to invest in home improvements.

Credit cards

Small upgrades and repairs can be made using a credit card. However, unless you have an unusually low, fixed interest rate, credit cards are one of the most expensive ways to pay for home renovations. Even if you snag a 0% promotional APR, it will likely expire in 18 months or less. Home renovation loans offer much longer repayment terms. For this reason, credit cards should be saved for emergencies only.

Government loans

The U.S. Department of Housing and Urban Development (HUD) offers a program called the FHA 203(k) loan. It allows you to include renovations in the amount financed for your mortgage, whether you're purchasing a home or refinancing your current mortgage.

The Federal National Mortgage Association (Fannie Mae) offers the HomeStyle Renovation Mortgage. Rather than take out a conventional (non-renovation) loan, a home buyer would take out the HomeStyle Renovation Mortgage. This loan gives the buyer enough to buy the property and make renovations. All work must be completed by contractors approved by the mortgage lender.

HUD offers Title 1 Property Improvement Loans that can be used for financing a home remodel. You can use this type of loan to pay for home repairs, alterations, and improvements. It can be used alone or in conjunction with the 203(k) loan.

Save and wait

If the home renovations you dream of are cosmetic, saving until you have enough to pay cash for the project can be wise. In many cases, cash is the best way to pay for home renovations. Instead of applying for financing, here are three main benefits of saving up when it comes time to redo part of your home:

• The best design is one you will want to live with for years. Waiting gives you time to decide what you want.
• Paying cash means not having to worry about repaying a loan.
• Paying cash may help you stick with a budget. It'll help you avoid impulsive purchases that could be tacked onto a loan amount.

For these reasons, many homeowners consider cash to be the best way to pay for home improvements.

What should I consider when financing home improvements?

The first question to ask yourself when considering how to finance home renovation costs: What monthly payment can you afford? A loan officer can help you determine the best path forward, whether it's through a mortgage with a longer loan term, a cash-out refinance, or a government-backed refinance that rolls renovations into the total cost.

There's no reason to go through the trouble of financing a remodel if you're stressed about making monthly payments. Consider what you want to include in the remodeling project and how much you're willing to pay for each feature. For example, if you want to duplicate the rain forest shower that you once enjoyed at a resort, look into the price to determine whether it's worth it to you.

If interest rates are on the rise, decide if you can wait to remodel. Finally, rate shop before settling on a lender. The perfect lender for you will offer the lowest interest rate and the best terms. Find the best financing for your home remodel before you start knocking out walls -- your wallet will thank you.

When is it a good idea to finance home renovations?

Financing home renovations is a good idea when you have enough money put away in an emergency savings account to cover bills for three to six months. It's also a good idea to have:

• A secure job
• A steady income
• Confidence that you can easily afford to make the monthly payments

When is it a bad idea to finance home renovations?

Financing home renovations is a bad idea when you are already cutting your monthly budget close. It's a bad idea when you're financing with a partner, but are unsure the relationship will last. It's also a bad idea if:

• Your job is less than secure
• You tend to spend more money than you earn
• Your credit score needs improvement

Is financing home improvement right for me?

Like all tough questions in life, whether or not you finance home improvements is up to you. The best you can do is to carefully look at your current situation, study your loan options, and when you're ready, make a decision you can be happy with. Financing home renovations is a big step, and it's one you should take only if it's the right choice for you.

Whether you make improvements all at once or complete them as you can afford to, it's good to know that you're moving toward making a house your own.

Still have questions?

We have guides to financing some specific home improvements. Click below to learn more about financing your project:

• Financing a bathroom remodel
• Financing a deck
• Financing a kitchen remodel
• Financing a pool
• Financing a roof
• Financing emergency home repairs
• Financing solar panels