Home Improvement Financing Options
It’s no secret that home improvement can be expensive. Depending on the type of project you’re trying to accomplish, your job could easily run five figures or more. On the more affordable side of the spectrum are simple, inexpensive projects like a new entry door or new garage door replacement, both of which average under $3,500, according to Remodeling Magazine’s 2018 Cost Vs. Value Report. On the more expensive end, projects like additions and remodels average costs as high as $256,000.
While that represents a significant investment, many homeowners find that the improved comfort, performance, and aesthetics are well worth the price. Some energy efficient projects can even decrease the cost of your energy bills, saving you money in the long run. Furthermore, when it comes to a necessary improvement such as a new roof or HVAC system, delaying a project until you’ve saved the money isn’t always an option.
Fortunately, paying out of pocket isn’t your only option. Your finance options will vary depending on your specific project, but using a home equity loan or line of credit, personal loan, FHA mortgage or loan, mortgage refinance, or credit cards are all popular ways to afford a home improvement when paying in cash isn’t possible. Of course, that means you’ll need to decide which method is right for you. Below you’ll find a detailed guide to your financing options to help you pick an option that’s right for your household.
Pay What You Can in Cash (and Reap State or Federal Tax Deductions or Credits)
As with most major purchases, paying in cash is best, since it will help you avoid interest and fees that could drive up the final cost of your improvement. Of course, that’s not always convenient or practical, especially with a larger project.
However, if you are able to pay a portion of the project cost in cash, you should do so. Lenders will often offer a lower interest rate if you put money down. Additionally, it will lower your monthly payments and, of course, you’ll be able to pay the full amount faster. You can also combine your cash payment with one of the following loan or credit options.
If you choose to pay cash in full to make an energy efficient improvement, you may be eligible for a rebate from the federal government, your state or local government, or your energy provider. For instance, if you’re looking for ways to finance solar panels, you’re in luck. Homeowners who install solar may receive a tax credit worth up to 30% of their project cost. See the official factsheet on the Residential Investment Tax Credit for more information. Your state or local government or electricity provider may have a similar rebate or credit program for solar, or for energy-efficient windows, HVAC, insulation or smart thermostats. Visit the Database of State Incentives for Renewables and Efficiency (DSIRE) for more information.
Home Equity Loans
A home equity loan is what people are referring to when they say they’ve taken out a second mortgage on their home. If you have equity in your home—in other words, if you’ve paid off a portion of your first mortgage—a lender may allow you to borrow a percentage of your home’s current value. In return, you agree to put up your home as collateral.
The math gets a little tricky if you’re still paying off your current mortgage. Essentially, here’s how it works: most lenders allow you to borrow up to 85% of your home’s current value. Some home equity loans will go as high as 100%, but that rate is unusual. This percentage is known as your home’s loan-to-value (LTV) ratio, and it varies depending on your financial institution. For instance, let’s say you bought your house for $300,000, and your lender agrees to provide an LTV of 85%. Assuming that price matches the current value of your home, you’d be able to borrow up to $255,000—theoretically.
That $255,000 is only hypothetical because the actual value of your home equity loan depends on the remaining loan balance on your first mortgage. Let’s assume, for instance, that you’ve already paid $100,000 on your home, leaving a $200,000 balance on your first loan. Your lender will subtract the $200,000 from $255,000, leaving $55,000 of available equity that you may borrow from.
Interest rates for home equity loans vary, depending on your lender and your credit history. However, you can expect to pay slightly higher rates than on your first mortgage. On the plus side, most home equity loans have fixed interest, which means you’ll pay the same rate throughout the life of your loan. The rates are also typically more favorable than those applied to personal loans. You should be aware, however, that there may be closing costs and fees associated with your loan.
Home equity loans make a good choice for a home improvement project, if:
- You’re planning a large project, improvement or renovation (a job that will cost over $10,000).
- You have established equity in your home.
- You feel comfortable borrowing against your home.
- You think you’ll be able to pay off an additional mortgage.
- You have a good credit history and have been paying your mortgage on time.
Home Equity Lines of Credit
Another way to borrow against your home’s value is to use a home equity line of credit, or HELOC. Although many people confuse HELOCs with home equity loans, they’re not quite the same. A HELOC is not necessarily a loan, but more similar to how a credit card works. The advantage to establishing a line of credit is that you can borrow multiple times once approved.
As with a home equity loan, your provider will typically offer 85% of your home’s current value, minus your remaining loan balance. However, whereas a home equity loan offers a one-time lump sum of money, the available credit on your HELOC is replenished as you pay off the balance. That means you can potentially draw from that amount to pay for additional projects in the future, much like you might with a credit card.
The key to a HELOC is that many providers offer them with a variable interest rate—that is, the interest rate you pay is subject to change from month to month. The value of that rate is set by the market using public indexes, such as the prime rate or the U.S. Treasury bill rate. Interest is calculated daily, similar to a credit card. Some providers may allow you to convert to a fixed rate after a portion of the balance is paid off.
Most HELOCs also stipulate a draw period, a fixed period of time during which you can access funds on your line of credit. After the draw period expires, you’ll either have to renew your credit line, pay your principal balance in full, or begin making monthly payments to pay off your principal. Again, your lender may charge you closing costs or fees to open your line of credit.
Home equity lines of credit make a good choice for a home improvement project, if:
- You need a large sum for your home improvement projects.
- You plan to pay for multiple improvements or projects with your home equity.
- You’re comfortable putting your home up as collateral.
- You don’t mind a variable interest rate.
Title I Loans
A home equity loan or line of credit doesn’t always make the best sense, particularly if you need to make an improvement on a newer home where you have little to no equity. For these situations, the US Department of Housing and Urban Development offers an alternative solution: Title 1 Loans.
Title 1 loans allow you to borrow up to $25,000 to make alterations, improvements or repairs on your existing home. Surface alterations, like paint, flooring, cabinets and other small aesthetic improvements are not typically eligible for Title 1 loans. Additionally, someone will need to have occupied the home for at least 90 days in order to qualify.
Your loan is insured by HUD and issued by a list of approved private lenders. If you decide to borrow more than $7,500, you must secure your loan with your mortgage deed or a trust on the property. The maximum loan term allowed by the government is 20 years.
Interest rates for Title 1 loans are fixed and determined by market rates in your area when you apply for your loan. However, like most Federal Housing Administration loans, the interest rates are typically fairly high, especially since the FHA appends a mortgage insurance premium of your loan, applied to your interest rate. The FHA may also look at your debt-to-income ratio before accepting your application.
Title 1 loans make a good choice for a home improvement project, if:
- You want a loan, but have little-to-no equity in your home.
- You plan on spending no more than $25,000.
- You plan on making a functional improvement, repair or alteration, not surface changes.
- You have a debt-to-income ratio under 45%.
- You feel comfortable with the idea of potentially securing your loan with the deed to your mortgage.
Energy Efficient Mortgages
A Title 1 loan is not the only way to receive an FHA-insured loan for improvements. If you’re planning to make changes that will improve your home’s energy performance, you may be eligible for a second mortgage insured by the FHA or the Department of Veterans Affairs (VA). Known as an Energy Efficient Mortgage (EEM), these loans can be used to fund energy-efficient projects around the home.
The only catch here is that only certain improvements qualify. However, projects like solar panels, high-performance HVAC systems, and energy-efficient windows are often eligible. Typically, the FHA will require you to have a home energy assessment performed beforehand to help you select qualifying energy improvement projects.
Like a Title 1 Loan, an EEM is backed by the government. Loan amounts top out at 5% of either the adjusted value of the home, 115% of the median price of a home in your area, or 150% of the Freddie Mac conforming loan limit, whichever is the smallest amount.
EEM loans are offered as either 15 or 30 year fixed-rate mortgage or as an adjustable rate mortgage. All mortgages are administered by FHA-approved lenders. Therefore, you must have an acceptable credit score in order to qualify.
Energy Efficient Mortgages make a good choice for a home improvement project, if:
- You plan on making an energy-efficient improvement on your home.
- You have a fairly good credit rating.
- You feel comfortable taking on a second mortgage on your home.
If you’re not comfortable with the idea of a home equity loan and have a good credit score, a personal loan is a worthy alternative to a home equity loan. Personal loans are unsecured, which means you don’t have to put up your home as collateral. Instead, your loan is secured by your credit history, stocks, bonds, certificates of deposit, savings account, pension or retirement account.
Terms and interest rates for personal loans vary depending on your FICO score and loan provider. In fact, interest rates may go as low as around 2.5% or as high as about 36%—a huge range. Typically, the terms on a personal loan are much shorter, with maximum payback periods topping out at around seven years.
Personal loans make a good choice for smaller projects, since lenders frequently administer these types of loans for a few thousand dollars. The minimum amount for a home equity loan, on the other hand, amounts to around $10,000.
Personal loans make a good choice for a home improvement project, if:
- You’re trying to fund a smaller project, improvement, or repair.
- You’re not comfortable taking out a second mortgage or securing your loan with your home.
- You have a fairly good credit score and credit history.
- You plan to pay back your loan in the next few years.
Once you have established some equity in your home, you have the option of refinancing your mortgage to adjust your payment amount, interest rate, terms, and loan amount. That last part is the key: you can potentially refinance your loan for a higher amount than your previous mortgage, and take out the difference in cash.
Typically, you’ll need to have established at least 20% equity in order to qualify. Additionally, unless you need to make an urgent repair, it really only makes sense to refinance if you can get a lower interest rate on your refinanced mortgage. Be sure to review current mortgage rates before you apply.
Cash-out refinancing makes a good choice for a home improvement project, if:
- You have at least 20% equity in your home.
- Mortgage rates are lower than when you first bought your home.
- You’re using the project to improve the value of your home.
Some larger contractors also offer their own payment plans. These loans may be interest free for a fixed period—usually between 12 to 18 months. After that period, the interest rates tend to be fairly high, typically around 28 to 29%. You may also owe backdated interest at that rate. However, if your contractor offers loans serviced by a third-party lender, the rates may be much more amenable—some range between 4 to 12%.
Contractor financing make a good choice for a home improvement project, if:
- You trust your contractor.
- You are able to pay off your loan before the interest-free period expires, or you are able to secure a good interest rate through a third-party lender.
For many homeowners, the obvious choice to afford a home improvement project is to use existing or new credit cards. Credit cards are convenient since there’s no loan approval process to go through. That makes them attractive if you need an immediate repair completed.
However, you may have higher interest rates on your credit cards than you might with a home equity line of credit or other loan. Additionally, it can damage your credit score to carry high balances over time on your credit cards.
Credit cards make a good choice for a home improvement project, if:
- You have little-to-no established equity in your home.
- You do not have time to wait for the approval process for a loan.
- You have a favorable credit limit and low interest rates on your existing credit cards.
- You’re planning to pay for a smaller improvement or repair.
- You will be able to pay off your balance quickly.
Loans for Low Credit
It is possible to get a home improvement loan with less-than-sterling credit. Some lenders will administer personal and home equity loans to recipients with poor credit scores—a few go as low as 580. However, you may have to contend with higher interest rates on these loans.
You’ll also want to consider your debt-to-income ratio—essentially, the amount of monthly debt payments you make on credit cards, mortgages, car loans and other debts versus the amount of income you earn every month. Typically, a debt-to-income ratio under 43% is considered “good.” Depending on your lender, this may be a determining factor in whether or not you’re able to secure a loan. Do make sure to do your research before applying for an alternative loan, since some “bad credit” loan providers have less-than-upstanding reputations.
If you have high monthly home payments, you may want to think about refinancing your mortgage before applying for a loan. You can also apply for a debt consolidation loan to minimize your monthly payments. And of course, it doesn’t hurt to start taking some steps to repair your credit, such as obtaining a copy of your credit report and making plans to pay on time—or contacting your creditors if you can’t.
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