Home improvements can cost a pretty penny, even if you do the work yourself. The materials alone are costly, but then you also have to pay for labor and sometimes even special contractors to do the work.
The ideal way to pay for home improvements is with cash, but what if you don’t have that kind of cash lying around? How should you finance your improvements?
Credit Cards are an Option
Depending on the scope of your home improvements, you may be able to finance the job with a credit card. You’ll be even better off if you can finance it with a 0% APR credit card. If you have good credit and you only have a little credit card debt outstanding, try to find a credit card that offers a 0% APR for at least 12 months.
Credit cards are typically easy to get, unless you have horrible credit or are in over your head in debt. The one thing you need to watch, though, is the terms of the card. Don’t just assume that you know what to expect. Read the fine print. Know when the 0% term expires. Also, know how the interest will be calculated on any balance that remains. You don’t want to find out the hard way that you have to pay interest on the entire balance.
Personal Loans Work in Some Cases
If your home improvements are more than minor, but aren’t so expensive that you need to touch your home’s equity, a personal loan might be a good option. Personal loans are often easy to obtain and they don’t use your house as collateral. It’s a win-win for you.
The thing to be careful with when it comes to personal loans, though, is the interest rate. Personal loans typically have higher interest rates than you could get on a home equity loan or line of credit. That’s because there’s no collateral. If you default on the loan, the lender doesn’t have anything to fall back on other than filing a judgment against you.
Home Equity Loans and Lines of Credit are Good for Large Renovations
If you are doing major home improvements, you may want to consider either a home equity loan or a home equity line of credit. As the names suggest, they both use your home as collateral. The two loans operate differently though.
Home equity loans work as follows:
- You get the full amount of the loan in one lump sum
- You pay a fixed interest rate for a 15 to 20-year term
- You cannot reuse the principal that you pay back
Home equity lines of credit work as follows:
- You get a line of credit that you can draw funds on as you need
- You pay a variable interest rate that is based on a specific index during the draw period
- You can reuse the principal that you pay back for the first 10 years (draw period)
- During the last 20 years, you repay the amount of the line of credit that you used
Both home equity loans and home equity lines of credit incur closing costs. The costs are typically lower than you’d pay on a first mortgage, but you still pay them.
Before you choose between a home equity loan and a HELOC, think about your home improvements. Are you doing one thing that you know the cost of and won’t have a need for future funds? If so, then you may be just fine with a home equity loan. You’ll have the benefit of the fixed interest rate and possibly a shorter term.
If you know your project will be ongoing or that you will have a future need for funds, you may be better off with a HELOC. This way you have the credit line available should you need to draw more funds in the future or have an emergency fund should something go wrong with your home improvements.
Cash-Out Refinances are an Option Too
Your final option is a cash-out refinance. This requires you to refinance your first mortgage and tap into your home’s equity. The ‘cash out’ portion of the loan is amount that you take out above and beyond the balance on your current first mortgage.
Cash-out refinances typically have higher interest rates and higher closing fees because of the riskiness of the loan. Lenders take a chance giving you a higher loan amount that you owe currently. Typically, the cash-out refinance should be your last resort since it will likely cost you more money in the end.
If you apply for a cash-out refinance, you’ll pay off your first mortgage and take out a new first mortgage. The new mortgage will have a higher principal balance and will start your term all over again, assuming you choose the same term. Give careful thought before choosing this option to make sure it’s affordable and doesn’t cost you too much in the end.
How you should finance home improvements depends on your financial situation. If you only need a small amount of money, try the credit card or personal loan route. If your home improvements are extensive and expensive, though, you may want to consider the home equity loan, line of credit, or cash-out refinance.