Financing Home Improvement Projects - A Guide

Whether you bought a fixer upper or are dreaming about a new kitchen, there’s a lot to know about home improvement loans. We’ve done the research for you to make your financial decisions easier. Read on to see what options are best for your situation and the different types of home equity loans out there.

Home Equity Loans

One way to finance home improvement projects is to use a home equity loan. Just like a primary mortgage, you’ll need to provide home mortgage documentation that shows your income and assets when you apply and the home equity loan uses your house as collateral. If you have equity and satisfactory credit, there’s a good possibility you can borrow against that home equity for home improvements. With this type of home equity loan, the borrowed amount is fixed which makes it an excellent option if you need money for a large one-time project. The interest rate is also fixed, which is a good thing when rates are down.

Keep in mind that with some home equity loans, you’ll have to factor in the cost of an appraisal along with closing costs which can add up. So, this type of home improvement loan is better for larger projects to justify the fees. Plus, since the loan is secured by your home, if you don’t make payments, you could risk foreclosure, so it really doesn’t make sense to take that risk for something like a paint upgrade.

Since these loans are almost like mortgages, the loan amounts can come in all sizes depending upon your needs. You can get funds for a complete rehab or money for individual home improvement projects like building an addition, replacing roof and gutters, installing an in-ground pool, remodeling the kitchen and bath, replacing old windows, and adding energy efficient upgrades.

Along with the enjoyment of a new kitchen or new pool or whatever you choose, when you upgrade your home, you’ll also be raising your property value. When in it comes to securing a home equity loan, there a wealth of different new home financing tips that can help.

Summary of Home Equity Loans

Loan Type: Fixed

Interest Rates: Depends on credit and equity

Credit Score: 620 - 700+

Collateral: The property

Fees: Home appraisal, closing costs

Perfect for: Kitchen and bath remodels, new roofs - any project that has a higher price tag

Home Equity Line of Credit

Sometimes called a HELOC, this type of loan also uses your home as collateral. The amount you can borrow is based on how much equity you have. For example, if your home is worth $400,000 and you have a $200,000 first mortgage you’d have $200,000 in equity. Most lenders will let you borrow up to 85% of your home’s value minus the primary mortgage.

Whereas a traditional home equity loan has a fixed loan amount and fixed-rate, the HELOC most likely has a variable rate. That means your loan might have a low introductory rate, but after that, your permanent interest could increase substantially depending upon what the prime rate does. It’s important to read the fine print, so you don’t have any surprises.

With a home equity line of credit, instead of getting one lump sum, you can draw the money out when you need it up to your loan limit. HELOCs are a smart choice when you have a long-term renovation or repair projects or when you have several future home improvements planned for the future.  Just like home equity loans, you’ll need good credit as well as having to pay for an appraisal, closings costs, and fees.

How to Calculate Max Line of Credit for a Home Equity Loan

Calculating your max potential for a home equity line of credit is as easy taking your home value, multiplying it by 85% and then subtracting your current mortgage:

Home Value X 85% - Mortgage = Max Line of Credit

Example:

Home Value = $400,000

Mortgage: $200,000

Borrowing Percent: 85%

$400,000 x 85% = $340,000

$340,000 – $200,000 = $140,000 (max line of credit)

Summary of HELOCS

Loan Type: Variable

Interest Rates: Depends on credit and equity

Credit Score: 620 - 700+

Collateral: The property

Fees: Home appraisal, closing costs

Perfect for: Larger home improvement projects that take several months to complete and need financing over an extended period.

Cash Out Refinance

If current rates are lower than what you currently have on your first mortgage and you have a good chunk of equity, you might consider a cash-out refinance for your next renovation loan. Getting a new fixed rate loan with money for renovations is possibly the least expensive way to finance home repairs and renovations. Plus, the interest may be tax deductible since it’s rolled into your first mortgage.

 But, this doesn’t work for those homeowners that already have a low rate. Depending upon the loan program, some cash-out refinance’s have a higher interest rate so, you should compare. Just like when you obtained your primary mortgage, you’d have the cost of an appraisal and closing costs. The math doesn’t work for every homeowner, and it isn’t worth it if you can’t beat your current rate.

Summary of Cash Out Refinances

Loan Type: Mostly fixed, sometimes variable

Interest Rates: Depends on credit and equity

Credit Score: Requires good credit (620 - 700+)

Collateral: The property

Fees: Home appraisal, closing costs

Perfect for: Homeowners with higher rates who want to refinance anyway; larger more costly projects

FHA Remodeling Loan

The US government offers a great deal on financing renovations. The FHA's Limited 203(K) mortgage program allows both homeowners and homebuyers to finance up to $35,000 into their FHA first mortgage for home improvements, repairs, and upgrades. This type of loan is ideal when you’re buying a fixer, and the FHA appraiser has identified items that need to be repaired (like a roof) before they can sign off.

Additionally, if a homeowner wants to make some repairs to sell their home, this is the loan for them. A 203K can be used for projects like a new kitchen, HVAC, flooring, or other interior and exterior improvements and repairs. And the great thing about FHA is they lend to borrowers with lower credit scores than most other lenders will.

Summary of FHA 203k

Loan Amounts: Vary depending upon location - check for limits

Interest Rates: Fixed

Credit Score: 580+

Collateral: The property

Fees: Home appraisal, closing costs

Pros: You can use one loan for both purchase and rehab

Cons: There are loan limits

Best for: Lower credit scores, projects under $35,000, and fixers

Other Renovation Loans & Options

The major advantage of any home improvement loan is that even if you don’t have the cash, you can start renovating right away. Here are other options you may or may not want to consider.

Using a Credit Card 0%

If you have a smaller project for $10,000 or less, check out 0% credit cards. Most banks offer this introductory rate for 12 to 15 months. But it’s important to know what the rate adjusts to after the introduction period because it could be as high as 23% or more and with a loan of $10,000 you’d be paying too much interest.

Where this type of credit is helpful is if you have some money coming in and you know you can pay the card off before the interest goes high. For example, if you’re getting a big tax refund, bonus, or if you’re self-employed and expect payment on a large job. This is the best renovation loan option for smaller projects.

Summary of 0% Credit Cards

Loan Amounts: $10,000 or less

Interest Rates: Can be very high after intro rate

Credit Score: 620 and above

Collateral: None

Fees: There may be a yearly fee

Pros: Fast, cheap money for 12 months

Cons: High rates after the intro period

Best for: Smaller projects and if you know you can pay the card off within 12 months

Contractor Financing

Although it might be convenient to have your contractor finance your renovation project, you may want to think twice. Generally, the interest and fees are higher, plus there can be hidden costs. It’s much better to keep the financing separate from the project price.

For example, if you are getting a new roof, you will want to compare apples to apples when you’re looking at all the bids. It’s best only to consider what the contractor is offering as far as project costs (materials and labor) and handle the financing separately. That way you can make sure you’re getting a fair deal on your job and the best rate and terms on the funding from your lender.

Like buying a car and using an auto loan, don’t fall into the trap of just looking at your monthly payment. You need to look at the price of the project and the cost of the renovation loan including the rate and any fees.

It’s another story if you’re having a new home built. In that case, you can get some great deals on the builder’s preferred lender. The top home builders offer incentives other banks can’t touch.

Summary of Contractor Financing

Loan Amounts: Vary depending upon the project

Interest Rates: Can be very high

Credit Score: Below 620 might be OK

Collateral: The property

Fees: There may be lots of hidden and junk fees

Pros: A one-stop shop for project and financing

Cons: High price loans and you’re tied to the contractor

Best for: Homeowners who are willing to thoroughly check out the contractor and lender to make sure they aren’t getting a bad deal

Unsecured Personal Loan

With an unsecured personal loan, you borrow the money based on your creditworthiness without using your home as collateral. The advantage is your home isn’t at risk of foreclosure if you don’t pay the loan back. You may have a family member that would be willing to loan you the money you need.

Banks as well offer unsecured personal loans for amounts under $10,000. Make sure you deal with a reputable source and stay away from non-bank loans that have exorbitant rates.

Big Box stores like Home Depot and Lowes provide funding for projects like HVAC, roofing, new kitchens, and bathrooms. Home Depot has a “project loan” where you can purchase products and installation during a 6-month timeframe. As with other offers from banks, there’s an intro rate (probably interest only) but, after the teaser rate, it’s higher and isn't interest only. So when you’re looking at this type of loan see what your payment will be after the introductory period.

Summary of Unsecured Loans

Loan Amounts: Usually under $10,000

Interest Rates: Low intro, high after that

Credit Score: 620+

Collateral: None

Fees: There can be yearly fees

Pros: Fast cash and approval

Cons: Rates can go sky high

Best for: Short term loans where you can pay it off

We hope this guide on home improvement loans has been helpful. If you’d like to learn more about mortgage and financing visit our learning center.  And, if after reading about how you can finance home improvement project you think a new home might better suit you, please take a look at our quality built new construction homes.

Contributed to Your Home blog by Carol Youmans

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Published 8.6.19