This post was originally published March 2018 and has been updated with additional content, resources, images, etc.
Murray Lampert has been designing, remodeling, and building homes in San Diego since 1975. During that time, we have seen many changes in home improvement financing. Thankfully, today there are great loan programs for consumers looking to build new homes or improve their current properties.
Before you get too far down the road with the excitement of designing your home remodel, custom kitchen, or in-law suite, it’s important to have a realistic idea of what a typical home renovation project costs.
We recommend establishing a budget, as well as outlining exactly how you are going to pay for your home remodeling project. With favorable interest rates and excellent loan programs, even if you have cash on hand, you may be better off holding on to it.
Below we’ve outlined some of the most popular options that homeowners consider before they begin a home renovation. It’s up to you to be cognizant of your unique financial situation and do what is best for you and your family. With any large investment, you should consider all outcomes and choose the direction that suits you best.
Option 1: Cash
Paying cash is almost always the best option when it comes to financing a home improvement project (versus taking out a line of credit). However, it’s not realistic to assume most homeowners have the funds for a major remodeling project readily available. In many cases, the average construction or remodeling project in San Diego County is not in the thousands of dollars, but in the hundreds of thousands.
Even if you could pay all cash, it’s probably not the best use of your savings unless you are doing a very small upgrade or improvement. For larger home remodeling projects, we recommend using cash to offset how much you’ll need to borrow. This is the safest option, but there are plenty more.
Option 2: Low-Interest Credit Cards
If you’re a homeowner, you’ve likely been teased with countless credit card offerings over your adult lifetime. If you’re credit is healthy, there is nothing wrong with putting small to medium sized home renovation projects on a zero perfect interest or low interest credit card.
They key here is to obviously pay this off quickly, so we don’t recommend putting a $20,000 project on a Visa. Honestly ask yourself, will I be able to pay this off before the credit card offer expires and I start to accrue interest? If you’re uncertain in any way, don’t do it.
But if you know you have great credit, and can pay off the balance in the right amount of time, this could be a viable option for you.
Option 3: Cash-Out Refinance
Depending on how long you’ve been in your home, a favorable option might be cash-out refinancing. A cash-out refinance is a good fit for major home repairs, renovations and construction projects. At the same you can consolidate high-interest debt. This program involves refinancing your home and taking out equity and also based on future value after improvements.
There are many lender options for cash-out refinancing. Start with your current mortgage holder, personal bank relationship or credit union. Compare those to other lenders or work with a design-build firm who has a relationship with a local bank.
Something to keep in mind when considering this option is the cost recoup of your particular renovation project. Since you’ll be using your home as collateral against a larger loan, it’s best to make improvements that will boost your home’s value. Do some research and ask your remodeling contractor about the expected cost recoup of various home remodeling projects before getting started.
Option 4: Home Equity Line of Credit (HELOC)
A home equity line of credit, or HELOC, uses the equity in your home to fund your remodeling project. The current low interest rates, minimal costs, and flexibility of accessing the funds makes this an attractive option. Presently, the APR on a HELOC is about 5.35%.
Something to consider with a HELOC is that you’ll be taking on more debt, using your home as collateral and making a second loan payment when you access funds. Additionally, you will typically need to have 15% to 20% equity in your home to qualify for a HELOC.
According to Nerd Wallet, “A home equity line of credit, so often referred to as a HELOC, is a convenient way to draw on the value of your home — and tap the equity only as you need it. That’s a good thing, because your home’s long-term value can be a real wealth-building tool.”
If you do this the right way, the advantages can be plentiful. One huge benefit is that HELOC funds used to improve your home may be tax-deductible. With that said, consumers should be aware of the risks associated with HELOC loans. Since there will be a lien on your property as collateral until the loan is paid off, you need to make your payments on time to avoid negative impact on your credit or foreclosure. HELOCs also carry a variable rate of interest until they convert, typically in 10 years.
Be sure to consult with a HELOC lender to fully understand all of your options. Nerd Wallet shares a few HELOC lenders that are worth considering.
Option 5: Personal Line of Credit (PLOC)
A personal line of credit, also known as a PLOC, is another option homeowners might use when looking for additional funds during their home improvement project.
So how does a personal line of credit work? Like a HELOC, a PLOC allows you to draw from a select set of funds over a set period of time called the draw period. Unlike a HELOC, however, PLOCs can be unsecured, meaning you do not need collateral to qualify for a PLOC.
Since using a PLOC gives you access to funds over a certain period of time, it can be a helpful option for people looking to do home upgrades. This is because homeowners can draw the amount of money they need, up to the limit, from their line of credit, while they work on their remodeling project. This flexibility can allow them to adjust for changes in their home improvement budget or cover additional expenses that come up.
Option 6: Construction Loan
In the pecking order, construction loans should only be considered for custom homes or major renovations. There are pluses and minuses for construction “take out” loans. This type of financing provides secure funding for building from the ground up or major renovations. The cost of money is reasonable, but the risk is the timeline of securing the permits and completing the build so the rate of the first mortgage can be locked in.
Speciality versions like FHA construction loans and VA construction loans offer flexibility for qualified borrowers, but according to Bank Rate, there are two main types of construction loans:
Construction-to-Permanent: You borrow to pay for construction. When you move in, the lender converts the loan balance into a permanent mortgage. It’s two loans in one.
Stand-Alone Construction: Your first loan pays for construction. When it’s time to move in, you get a mortgage to pay off the construction debt. It’s two separate loans.
Option 7: HUD Title 1, FHA 203k, or Homestyle Loans
These loans are for homeowners with a modest income level. Bear in mind, the closing costs, fees and inspection charges make these loans very expensive with high APR. Besides credit card financing, these programs are by far the most expensive money to borrow. According to the Department of Housing and Urban Development requirements, they are not intended to be used for luxurious or fancy upgrades to your home.
Some homeowners apply for these loans to improve universal living - accessibility of a home for aging in place, people with disabilities, to undertake minor improvements such as replacement of HVAC systems, water heaters, minor remodeling etc.
HUD and FHA loans are issued by private lenders but backed by the government. Most lenders require the borrower to use their home as collateral for loans amounts above $7,500. For more info, visit Hud.gov.