One of the most daunting hurdles to fixing up an old house is the financial aspect: how do you afford to renovate a fixer-upper? Dreaming about what improvements to make is the fun part (for most of us anyway), but figuring out how to afford them is the scary part. Here we’ll talk you through best practices for how to finance your major home renovation projects.
Roughly Budget What You’ll Need
Once you settle on the gist of the work involved for the renovation, it’s time to budget. It is this point when, yes, reality will crash down on you.
Budgeting and getting accurate pricing is super important at this stage of the game because 1) we’ve had lazy budgets balloon to 50% – 100% the cost we thought and 2) the amount of money you need likely will affect how you decide to pay for the project. Is it a $1,000 job that we may just want to save up for? Or is it a $15,000 job and we really need to get financing??
Below I will walk you through a few of the options for financing home projects. Each option has plusses and minuses. Take your time and consider all the options before making any decisions.
Checking Out Financing Options
Oh, and when it comes to financing, the Internet is your friend! Sites like bankrate.com or nerdwallet.com can help you compare rates between lots of different lenders. (Don’t be surprised when you are quoted a different / worse rate than the one advertised once you contact the lender.)
Also be aware, sites like these mostly just get data from the large lenders (like Bank of America or Loan Depot), so I highly encourage you to go to a local bank or credit union to scout their rates. We’ve gotten crazy good deals from local banks that the big companies never would have offered.
Alright, let’s talk financing!
While not everyone may qualify for a home equity line of credit (HELOC), I think it is the best option for 1) surprise repair projects and 2) lengthy projects.
HELOCS work similarly to credit cards where a bank agrees to let you borrow a certain amount, and you are able to get cash up to that borrowing amount whenever you want.
A HELOC uses your home as collateral for the loan; this is good in that banks will generally give better rates when a loan is backed by collateral (i.e. if you don’t pay your loan, they take your house), but it can be bad because it gives the bank a very easy way to foreclose on (i.e. take) your house.
If you have great credit scores, lots of equity in your house, and low debt-to-income ratio (i.e. all of your paychecks don’t go toward your mortgage), good rates run around 3-4% right now. However, if you have (say) bad credit, you could be looking as high as 9-10%.
A big plus here is that your monthly payment is determined by how much you have borrowed, so if you borrow $15k and then pay back $10k the next month, your ongoing payments will be based on the $5k you have outstanding and not the original borrowed amount (this works very differently from mortgages or personal loans, which we’ll talk about later).
A big minus here is that the terms of the loan usually do not fix the interest rate charged, meaning it can go up or down each month. Also, you will have to have at least 15% (usually 20% or more) equity in your house to even qualify for a HELOC.
Refinancing your home could be a great option for larger, value-building projects like totally redoing a kitchen or building an addition.
If you have sufficient equity in your home, you may qualify for a cash-out refinance, where a bank gives you a brand new mortgage with a larger loan amount than you have now so they can send you a pile of cash! But there are a lot of caveats before you get all excited about a pile of cash!!
Refinancing your home is pretty much the same process as getting your original mortgage on your home, including (and especially) a seemingly endless list of fees. These fees can add up Very quickly, so don’t take them lightly. When it’s all said and done, you have a new mortgage with a new payment amount and a new interest rate.
Be aware that cash-out refinances often have slightly worse interest rates than purchase mortgages or even cash-neutral refinances. Good rates for a fixed rate cash-out refinance right now run around 3.5%. Depending on a lot of factors (like your current payment vs the new payment, the amount you want to take out vs the fees), this could be a good way to get cash for renovations.
A big plus here is that you get all of the money up front and have just one loan. It’s overall a pretty “clean” way to get cash. A refinance also uses your home as collateral, so just like the HELOC, your rate is pretty good.
A big minus here is that these loans will last up to 30 years, so any increase in mortgage payment likely will be around for a while. Additionally, this strategy really only works if you have sufficient equity.
3. Home Equity Loan
A home equity loan, aka second mortgage, could really work well for fixed budget, medium sized projects like redoing multiple bathrooms.
A home equity loan (not a HELOC) has some features of a HELOC and some like a refinance.
Firstly, it uses your home as collateral so you can borrow against equity, which both HELOCs and refinances have.
However, like a HELOC, it is a separate, second loan against your house and does not replace your existing mortgage; this means you make two payments each month. Once you pay off the second mortgage, you go back to having just your original mortgage payment (which could be great if interest rates are going up).
Like a refinance, a home equity loan gets you a lump sum of money. Your payment is generally set until the loan is entirely paid off. If you end up over budget on your project, you may have to resort to less desirable ways of getting more cash like credit cards or personal loans. We’ll go into those options in a bit.
Home equity loans often have slightly worse rates than cash-out refinances. Right now it looks like they are around 5% for a good rate.
A big plus here is that it contains some of the good flexibility of both a HELOC and a refinance, and often will carry smaller closing costs than a refi.
A big minus here is that it will almost certainly have a higher interest rate than a HELOC or a refinance.
4. Personal Loan
Personal loans come in a lot of flavors (such as a home remodel / home repair loan) do work well for smaller projects like window replacement or redoing one bathroom.
A personal loan is different from the others mentioned thus far because the lender does not use your house as collateral (i.e. unsecured). This means the lender would have a tougher time taking your house if you don’t pay. That means it is riskier for them. Thus, personal loans will have higher interest rates than HELOCs, refinances, or home equity loans. Since a personal loan does not involve your house, they are often much faster to get cash. They often will have far fewer fees. Structurally, personal loans usually have shorter repayment timelines and smaller loan amounts. This is why I think they work best for not-huge-budget projects.
Right now, it looks like a good rate for a home improvement loan will run about 6%. This is obviously the highest rate so far (but just wait til you see credit card rates!).
A big plus here is the speed and flexibility that can really come in handy for some of the smaller but still very important projects you may want to tackle.
A big minus here is that you will definitely end up paying a higher interest rate and likely will not be able to get as large of a loan.
5. Credit Cards
Honestly, I cannot recommend using a credit card as a loan mechanism because they are such a slippery slope. If for some reason you don’t have any other choice in an emergency situation, credit cards can work. Some folks will say cards are ok for very small things like ceiling fixtures. In my opinion, you can wait a few months to pay cash for smaller stuff rather than pay the astronomical interest rates on cards.
Like a personal loan, the credit card company makes a loan that is is unsecured (i.e. not collateralized). Like a HELOC, you only pay interest on the outstanding balance. However– the interest you pay will be well over 10%, so if you don’t pay off your balance each month, the credit card company will charge some crazy interest.
Right now, it looks like people with excellent credit can get a card with a rate around 13%. If you only have good credit, rates can spike up to 19%. (Rates climb quickly as your credit scores go down.)
A big plus here is that once you get a card, you are allowed to spend up to the limit usually with no questions asked. It can help fill a gap when paying for emergency projects.
A big minus here is that cards cost a lot in interest and contractors often do not accept them. Getting cash from a credit card will result in quite large fees. Exercise caution before thinking you can depend on credit cards.