How to Finance Home Renovations

Financing your home renovation

When planning a home renovation, it's important to look past the "sticker price" and consider the different financing options available to make your dream home a reality. The right choice depends on your budget, current credit, and how much equity you have in your property.

This guide covers a range of financing methods, including:

• Home equity loans
• Home equity lines of credit (HELOCs)
• Cash-out refinancing
• Personal loans
• Credit cards

1. Home equity loans

If you have paid off a significant portion of your mortgage, a home equity loan allows you to borrow a lump sum using your home equity as collateral. This is essentially a second mortgage. As with any loan, your ability to take out a home equity loan is dependent on your credit and your ability to pay off the loan.

You receive the funds all at once, which is helpful for expensive home improvements with a fixed quote. Still, all loans have drawbacks.

A home equity loan reduces the available equity in your home and requires you to make monthly payments alongside the original mortgage you’re already paying. Lenders use the amount you want to borrow and the length of the loan term to calculate your monthly rate.

For example, a home renovation loan of $21,000 at 6% interest would cost around $230 per month if you paid it off in 10 years. If you paid it off in 20 years, it would cost $150 per month.

» READ MORE: Home remodeling ROI: Costs vs. value

2. Home equity line of credit (HELOC)

A home equity line of credit, or HELOC, also uses your home’s equity as collateral. However, instead of receiving a lump sum, you are approved for a maximum amount and can withdraw funds as needed via checks or a debit card.

HELOCs are typically available over a specified amount of time, usually a “draw period” of 10 to 20 years, and then the line of credit ends.

They are particularly useful if you aren't sure exactly how much your project will cost or if you are renovating in stages. Be aware that HELOC interest rates are typically variable, so your payments may increase if market rates rise.

3. Cash-out refinancing

A cash-out refinance replaces your current mortgage with a new, larger loan. As a homeowner, you might be eligible for cash-out refinancing if your home value is worth more than what you owe, whether because of years of payments or an increase in local market value.

With cash-out refinancing, you receive the difference between the two loans in cash. You can use the excess to fund your home renovation project.

Unlike a home equity loan, which adds a second payment, a cash-out refinance creates a single new mortgage. These typically offer better interest rates than home equity loans or other second mortgages, but you’ll likely have to pay closing costs again.

4. Personal loans

If you’re planning a large renovation and don’t have equity in your home or don't want to use your home as collateral, a personal loan can be a strong alternative. On average, personal loans range from $1,000 to $50,000, though larger amounts are available.

Interest rates for personal loans often average around 10%, depending on your credit score and location. While this is pricier than home equity loans, it’s still generally more affordable than a standard credit card. Repayment terms typically range from one to five years. Longer repayment terms reduce your monthly payments, but you pay more in interest over the life of the loan.

» LEARN: Construction loans: What they are and how they work

5. Credit cards

Around a third of homeowners use credit cards for home improvement projects. They are convenient for smaller projects and can offer rewards like airline miles or cash back, but they’re only worth opening if you can pay them on time.

The primary risk is high interest. For example, if you spend $3,000 on a credit card with a 17% interest rate and only make the minimum monthly payment of $72.50, it would take you 63 months and an extra $1,500 in interest to pay off the whole debt.

Always talk with a financial professional before taking out a large amount of credit, as it could end up harming your finances.

FAQ

Bottom line

Financing home improvements can be tricky. Building your savings and paying in cash is always the safest choice, but it’s not always feasible. Without a large savings account, you may need to take out a home renovation loan. Talk your options out with a local bank or financial advisor before making a decision — these choices can affect your personal finances for years to come.