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It might be a leaky roof, an outdated kitchen or a bathroom that needs an upgrade. Whatever the project, most homeowners have something they’d like to fix or improve. The challenge is often the cost. Home improvement projects can easily exceed five figures, and many people don’t have that kind of cash on hand. While there are plenty of financing options available, they aren’t all the same, making it important to understand how each one works so you can choose what fits your situation.
A financial advisor can help you weigh different financing options and figure out how to balance your current needs with your long-term financial goals.
Financing Options for Home Improvement Projects
Whether you’re renovating a kitchen, replacing a roof or adding a new room, home improvement projects can get expensive fast.
Most homeowners don’t have enough cash in a savings account to cover a major renovation. This is where financing often comes into play.
There are several ways to fund a home improvement project, each with its own advantages, costs and trade-offs.
Home Equity Loans
A home equity loan allows you to borrow a lump sum against the equity you’ve built in your home. These loans come with a fixed interest rate and a set repayment schedule.
Because of this, they are predictable and allow for easy budgeting.
Home Equity Line of Credit (HELOC)
A home equity line of credit (HELOC) functions more like a credit card than a traditional loan. With its revolving line of credit, you can draw from these funds as needed during a set period.
This makes a HELOC suitable for projects with unpredictable costs or phased renovations with expenses spread out over time.
Cash-Out Refinancing
With a cash-out refinance, you replace your existing mortgage with a new, larger one and pocket the difference in cash.
This option can make sense when current mortgage rates are favorable. It can also be an ideal solution if you need a significant amount of money for a large-scale renovation.
Personal Loans
For homeowners without significant equity, a personal loan offers an alternative. It also spares homeowners from having to use their home as collateral, like with a secured loan.
These unsecured loans are typically funded quickly without a home appraisal, making them a great option in a pinch. They can also be a convenient option for smaller or time-sensitive projects.
Government Programs and Loans
Certain government-backed programs can help homeowners finance improvements. This is especially the case for improvements related to energy efficiency or accessibility. FHA 203(k) loans, for example, allow buyers to finance both home purchases and renovations within a single mortgage.
Should You Finance a Project Using Equity?
Tapping into your home equity is one of the most popular ways to fund a renovation, and for good reason. The rates are generally lower, and the borrowing limits are higher than most other financing options.
However, just because you can borrow against your equity doesn’t always mean you should. Risking your home as collateral is a significant financial decision that deserves careful thought before signing on the dotted line.
The most important thing to understand about equity-based financing is that your home is on the line. If you default on your mortgage, the lender can legally foreclose on your property, regardless of your equity.
This risk is manageable when your income is stable and your budget can comfortably absorb the additional monthly payment. However, it becomes dangerous if your financial situation changes unexpectedly.
Financing through equity often makes the most sense when the project meaningfully boosts your home’s value or addresses a critical structural need. A kitchen overhaul, a bathroom addition and a new roof often deliver a solid return on investment, justifying the borrowing cost.
If you have substantial equity, strong credit and a stable income, a home equity loan or HELOC for a high-impact project can offer the most cost-effective financing strategy available.
How to Find the Right Financing Program For You
Before even comparing lenders or loan products, it is important to get a general idea of costs for your project. Start by collecting multiple quotes from contractors and then compare them.
Be sure to build in a contingency of at least 10-15% for unexpected expenses. This will help you determine how much you actually need to borrow. By having this number upfront, it prevents you from overborrowing or choosing the wrong financing product for the project’s scale. After all, a $5,000 bathroom refresh and a $75,000 kitchen renovation call for very different approaches.
Several factors play a role in which financing options are realistically available to you.
- Credit score
- Existing debt
- Income stability
- Available equity
Borrowers with strong credit and significant home equity have the widest range of products and the most favorable rates. If you don’t have a good credit score or your equity is limited, a home equity product may not be right for you. You may be better served by a personal loan or a government-backed program.
It’s tempting to choose a loan based solely on the interest rate, but that number doesn’t tell the whole story. There are several factors to consider that can add significantly to the total cost of borrowing.
- Origination charges
- Closing costs
- Appraisal fees
- Annual maintenance charges
- Repayment terms
- Prepayment penalties
- Whether the rate is fixed or variable
Tips for Financing Your Home Improvement Project
No matter what financing you choose, a few smart habits can help you maximize your investment while avoiding common mistakes. The decisions you make before and during the borrowing process can have a lasting impact on your finances long after renovations are complete.
When borrowing money, keep these tips in mind.
Read the Fine Print Carefully
Before signing any loan agreement, make sure you understand the full terms. This includes prepayment penalties, as well as rate adjustment schedules for variable products. Look for any fees that aren’t immediately obvious.
Overlooking a single clause can cost you significantly over the life of the loan.
Improve Your Credit Before Applying
Even a modest improvement in your credit score can qualify you for better interest rates and more favorable loan terms. Pay down existing balances, and dispute any errors on your credit report. Also, avoid opening new accounts in the months leading up to your application.
These actions can all help increase your credit score so you can qualify for a better loan.
Only Borrow What You Need
It can be tempting to take out extra money for upgrades that aren’t strictly necessary. However, every additional dollar you borrow comes with interest attached.
Stick to a well-defined project budget, and resist the urge to expand the project just because additional financing is available.
Build a Contingency Fund Into Your Plan
Home improvement projects almost always encounter unexpected costs. This could be hidden water damage behind a wall or a price increase for materials mid-project.
Whatever surprises lie ahead, it is critical to account for them with a contingency fund so you don’t encounter issues after work has already begun.
Bottom Line
Financing a home improvement project is a significant financial decision that involves more than choosing the first loan option available. Options such as home equity loans, HELOCs, personal loans, cash-out refinancing and government programs each come with distinct benefits, costs and risks. Selecting the right approach depends on the scope of the project, your financial situation and your long-term plans for the home.
“One type of financing that’s usually best to avoid when tackling a home improvement project is a credit card,” Loudenback said. “A credit card may feel like the easiest option, and it often is, but it can come with heavy financial consequences thanks to exceptionally high interest rates.”
However, there can be limited exceptions for certain borrowers with strong credit profiles.
“That said, if you have a great credit profile you may be able to qualify for a 0% introductory APR credit card, which can offer a quick, simple solution for a short-term home renovation project — as long as you repay the balance before the intro period is up,” Loudenback said.
Tanza Loudenback, Certified Financial Planner™ (CFP®), provided the quote used in this article. Please note that Tanza is not a participant in SmartAsset AMP, is not an employee of SmartAsset and has been compensated. The opinion voiced in the quote is for general information only and is not intended to provide specific advice or recommendations.
Financial Planning Tips for Homeowners
- A financial advisor can help you manage homeownership costs, choose the right financing options and stay aligned with your long-term financial goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to figure out how much you can spend on a home, SmartAsset’s affordability calculator can help you estimate how much house you can afford based on several key inputs.
- If you want to know how much your money could grow over time, SmartAsset’s investment calculator could help you get an estimate.
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