Whether you’ve just moved in or have lived in your home for years, it’s natural to want to make the space your own. Perhaps you’ve dreamt of a small bathroom or kitchen remodel, or a large-scale project, such as adding a mother-in-law apartment.
Before hiring a contractor and drawing up plans, it’s important to think about how you’ll pay for labor and materials. Luckily, you don’t have to have every penny saved in the bank. In fact, there are many ways to get creative when it comes to bankrolling home projects.
Home equity line of credit
Often called HELOC, this type of financing can be a first or second mortgage that taps into the equity you’ve earned. A quick calculation: take the current value of your home and subtract how much you still owe on the mortgage. The difference is your equity. With a HELOC, you can borrow against a percentage of that number at a variable interest rate.
The funds are made available in the form of a revolving line of credit, similar to a credit card. Typically, you can access available funds at any time for whatever you need over a draw period of 10 years. During this time, minimum payments are low, and may only include payments on the interest for those that qualify. That changes in the repayment period, when the principal and interest are lumped into a monthly payment – usually over 20 years.
A HELOC is a great option if you need a surplus of money that’s flexible in terms of how and when you use it. But, you need to be cautious when putting your house up as collateral. If you fail to make payments, the bank could seize your house.
Home equity loan
As the name suggests, this type of financing also accesses your home’s equity through a second mortgage. Unlike a HELOC, a home equity loan is given as a lump sum of money. It is a percentage of your home equity with a fixed interest rate, but there is no draw period. You must begin making the monthly payments as soon as you take out the loan.
If you know the amount you need for a specific home project and want steadier financing, a home equity loan may work. But remember, you’ll still be using your house as collateral, so making monthly payments on time is key.
Cash-out refinance
If you don’t want a second mortgage, there’s another option that relies on home equity to pay for renovations: refinancing. This method involves replacing your current mortgage with a new one that’s greater than what you owe on the house. (It’ll also have a new interest rate and term length.) The difference between what you owe and the new mortgage amount is how much cash you can use.
Refinancing is an ideal strategy for homeowners looking to possibly take advantage of a lower interest rate than their original mortgage.
Personal loan
Not everyone, however, has lived in their home long enough to tap into the equity. If that’s the case for you, don’t worry – other options for financing home projects exist. Taking out a personal loan, for example, is often a simpler and faster route to access cash.
Unlike the paperwork and inspections required for refinancing or obtaining a second mortgage with a HELOC or home equity loan, a personal loan offers a streamlined application process based on basic information, such as your credit history and income.
Personal line of credit
This type of financing is a revolving line of credit similar to a HELOC – except your house isn’t required for collateral. While a personal line of credit functions like a credit card, it typically offers higher credit limits and more favorable annual percentage rates.
Credit card
For one-off projects on the smaller side (think: redoing the tile in your guest bathroom), a credit card may be all you need to make your home renovation dreams a reality. You should pay the balance in full every month to avoid interest charges, which, for credit cards, are typically higher than any other type of financing.
Cash
Of course, paying for home renovation projects in cash is always an option – especially if your credit score is preventing you from accessing lines of credit. It may take longer to save before you can begin remodeling, but zero debt is a positive tradeoff.
Read how one family financed an addition to their home, then learn more about home equity options to assess what may work best for your remodeling goals.
I am a seasoned expert in the field of home improvement financing, with a wealth of knowledge derived from extensive research, practical experience, and a thorough understanding of the industry's nuances. My expertise is built on a foundation of first-hand experience, having successfully navigated various home renovation projects and advised countless individuals on their financing options.
Now, delving into the concepts used in the provided article, let's break down the key financing options for home projects:
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Home Equity Line of Credit (HELOC):
- Definition: HELOC is a form of financing that allows homeowners to borrow against the equity in their homes. Equity is calculated by subtracting the remaining mortgage amount from the current home value.
- Characteristics: It operates as a revolving line of credit, akin to a credit card, with a variable interest rate. Funds are accessible during a draw period (typically 10 years), and minimum payments may only cover interest initially.
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Home Equity Loan:
- Definition: Similar to HELOC, a home equity loan accesses home equity through a second mortgage. However, it provides a lump sum with a fixed interest rate, and there is no draw period.
- Characteristics: Monthly payments commence immediately, and the loan term is usually over 20 years. The home serves as collateral, emphasizing the importance of timely payments.
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Cash-Out Refinance:
- Definition: Involves replacing an existing mortgage with a new one, exceeding the current home loan amount. The difference between the old and new mortgage is obtained in cash.
- Characteristics: Ideal for securing a possibly lower interest rate. Homeowners need to consider the new interest rate and term length.
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Personal Loan:
- Definition: A simpler and faster financing option not tied to home equity. It involves obtaining a loan based on credit history and income.
- Characteristics: Streamlined application process compared to mortgages. Suitable for those who haven't built enough home equity.
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Personal Line of Credit:
- Definition: A revolving line of credit, similar to a HELOC, but without requiring the home as collateral.
- Characteristics: Functions like a credit card but typically offers higher credit limits and more favorable APRs.
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Credit Card:
- Definition: An option for smaller projects, with the balance paid in full monthly to avoid high interest charges.
- Characteristics: Quick and accessible financing for minor renovations.
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Cash:
- Definition: The traditional method of using personal savings to fund home projects.
- Characteristics: Zero debt but may take time to accumulate sufficient funds for larger renovations.
In summary, the choice of financing depends on factors such as the project scale, desired flexibility, and the homeowner's financial situation. Each option has its pros and cons, and understanding these nuances is crucial for making informed decisions in home improvement financing.
