There are endless reasons for renovating your home. Besides increasing home value, especially if you plan to list it for sale soon, home remodeling provides an opportunity to fix various safety issues, make design changes to improve comfort, and replace old and outdated appliances. Any renovation project heavily relies on having a strategic plan for success. Among the many things homeowners should feature in the plan is the renovation budget and how to finance the project.
A recent survey by Home Advisor found that homeowners spend at least $47,000 on average renovations. That said, before you start anticipating your modern kitchen and bathroom space or a smart-home system, you should determine your budget. Homeowners also require a specialized inspection from accredited agencies, such as NWCC, especially if they need renovation loans.
Below are financing options homeowners can use to pay for a home remodel.
Paying for home renovations using cash is the least expensive option, as it eliminates the interest and fees of loans. However, paying cash is only suitable for renovation projects that aren’t urgent; because you’ll need to save enough to meet your renovation budget. It is also an excellent option for small renovation projects.
2. Home Equity Loan
Taking a home equity loan, also known as a second line of credit, can also finance the remodeling project. However, you should meet basic qualifications to qualify for home equity loans. Most lenders require homeowners to have an 80% or less loan-to-value ratio. This means your home equity should be at least 20%. For instance, if your home is valued at $400,000, you should have $80,000 or more in equity.
Home equity loans are usually paid out as a lump sum, and most lenders only approve loans above $25,000 for major renovations. Home equity loans have fixed interest rates, and borrowers should repay consistent monthly payments over the duration. Because it is a secured loan, with your home as collateral, you can enjoy low-interest rates.
3. Personal Loan
If you have less than 20% home equity or don’t want to use your home equity as collateral, consider taking a personal loan to finance your home remodel. Getting approved for personal loans is easy from banks, credit unions, and lenders at low rates and fees.
Personal loans are unsecured because your home or any other asset can’t be used as collateral. However, interest rates differ, majorly depending on your credit score and history. Homeowners with higher scores have a better chance of getting low-interest rates. Personal loans are an excellent option for small to mid-size home remodeling projects.
4. Mortgage Refinance
If you don’t want to take a loan for home improvement projects, consider cashing out on mortgage refinance. Cash-out refinances ideally replace your pending mortgage with a new loan with better interest rates. With this, you can use the difference between the old and new mortgage loans to finance your remodeling project.
Mortgage refinance is an excellent option for homeowners who can’t afford additional monthly payments from other loans. Like home equity loans, mortgage refinances tap into home equity and can only be accessed by homeowners with more than 20% equity in their property. Mortgage refinance is a perfect option for large renovation projects that increase home value, such as kitchen remodeling and room addition.
5. Home Equity Line of Credit
Home equity line of credit closely resembles home equity loans, as it taps into home equity, which should be at least 20%. However, HELOC works differently and is more flexible. For instance, homeowners aren’t given a one-time lump sum. Instead, the amount equivalent to your home equity is used as a revolving credit that homeowners can use during the renovation.
Unlike home equity loans, HELOCs don’t have closing costs and variable interest rates. The repayment schedule also varies. Similarly, HELOCs are given in two phases, the draw and repayment period. The draw period lasts ten years, and homeowners can use the available credit during this period.
During the repayment period, which lasts 15 to 20 years, homeowners can’t withdraw funds, and monthly payments made during this period include the principal amount and interest. HELOC is an excellent option for multi-phased or long-term home renovations. This loan gives you the flexibility and convenience to tap into your line of credit over time. However, remember that HELOCs are secured loans backed by home equity. Therefore, your home is at risk of foreclosure if you miss payments.
6. Credit Cards
Small projects, like bathroom tiles and closet replacement, can be financed with a credit card loan. Most credit cards offer zero-to-low interest for the first months. Therefore, if you can complete your renovation project within weeks, you can avoid interest from this loan.
That aside, homeowners can also earn rewards from credit card use. Most cards offer excellent points and cash-back to homeowners who spend on renovation. However, the main risk associated with using this financing option is the high-interest rates. Homeowners who fail to repay the loan before the introductory offer expires incur significantly high-interest rates.
How Much Can You Borrow?
Whether you intend to DIY the remodel or hire a contractor, you should begin by estimating the project cost. Ideally, you should have an estimate of the renovation costs before approaching a lender. While most lenders promise huge loan amounts, your loan amount depends on your income, credit rating, and loan-to-value ratio. These key determinants influence the loan period, interest rates, and other factors.
- Credit rating – homeowners with an A credit rating can access large amounts at good rates.
- Loan-to-value rating – lenders often use the loan-to-value ratio (a percentage of your home's appraisal value) to determine your loan amount.
- Income – homeowners should have minimal expenses and less than 36% debt on gross monthly income to qualify for reasonable amounts at favorable rates.
Initially, financing your kitchen renovation, garage door replacement, or bathroom remodel is quite challenging. Homeowners had to rely on banks and few lending institutions. This has changed, and homeowners can now access several loans to finance their home improvement projects. With many competing lenders, you should shop for renovation loans with favorable terms and low-interest rates.
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