Tips for Financing Home Improvements
When it’s time to invest more into your home, most of us need to borrow. There are endless variations on project funding, but almost all fall into these five categories.
Credit or Loans?
Zero Percent or Low-Interest Credit Cards
If you have decent credit, you probably receive offers for zero percent interest credit cards. These are new credit cards, or checks you can use with cards you already have. Credit Karma advises that these offers are best for projects under $15,000 because it’s easier to pay off the loan within the low-interest-rate timeline, which is usually 12 to 18 months. Typically it’s easy to qualify for these offers, and your home doesn’t need to be used as collateral.
Make sure you can pay off the debt by the time the offer expires, or you’ll end up owing a ton of interest on the full amount.
Personal or Unsecured Loans
For projects from $15,000 to $50,000, Credit Karma recommends personal or unsecured loans. These loans are easy to apply for, don’t require any collateral, and tend to offer higher loan amounts than credit cards.
However, interest rates are typically higher on personal and unsecured loans than they are on home equity or home equity line of credit (HELOC) loans. Compare the terms, APR (annual percentage rate), and other costs of each loan to see which one makes the most sense.
Using Your Home as Collateral
If you have equity in your home and the project costs $50,000 or more, it’s best to use loans tied to your property. To reduce risk, lenders limit the amount of loans on your home to about 85 percent of your home’s value. Even so, it’s easy to borrow more money than you can handle and end up owing more than your home is worth.
Here are the most popular options:
Refinance with cash-out
This means replacing your current mortgage with a new one and taking cash out for improvements. A cash-out makes sense in some scenarios, especially if your mortgage rate is much higher than current rates. The long repayment period is nice, and monthly payments are lower than with a home equity loan or line of credit.
Keep in mind that closing costs may be high, and your APR will be higher than if you refinanced without getting cash out. Also, you’ll owe more on your mortgage. If you’re 10 years into your 30-year fixed mortgage and refinance into a bigger 30-year loan, the clock restarts.
Home Equity Loans (HEL)
Home equity loans are a second mortgage on your home. They’re usually a fixed interest rate, and you get the money in one lump sum. Terms vary, but many home equity loans require you pay back the principal and interest within 15 years. This is a good option if you need a set amount and can make the payments.
However, home equity loans can be pricey, with closing costs similar to those of a primary mortgage. There might also be a penalty if you pay off the loan early.
Home Equity Line of Credit (HELOC)
Instead of giving you all the money you qualify for at once, a HELOC gives you a revolving open credit line. That way you can borrow money periodically. Terms vary, but many HELOCs give you five to 10 years to access the credit line. During that time you pay interest on what you borrow, and you have 15 years or so to pay it back in full.
HELOCs, however, are adjustable rate mortgages, so rates can fluctuate and end up much higher than with a fixed home equity loan. But there are usually no closing costs on HELOCs.
Tip: If you have the cash, consider paying by credit card anyway to get the rewards (cash back, airline miles, etc.)