7 Ways To Pay For Your Home Improvement Project
Are you planning a home improvement project? If so, chances are you’ve contemplated how to pay for it. While there are many options to choose from, everyone’s circumstances vary, and each project is unique. Consider your options to see if one stands out above the rest.
- Cash. If you have enough cash to pay for your home improvements with excess to spare, this may be the overall best approach. Not only would you save yourself from paying interest on borrowed debt, paying in cash may also broaden the pool of available contractors for hire or give you negotiating power to haggle. Do your research. If it’s possible to borrow the money at a cheaper rate than your gains on investments, it may make sense to borrow. Otherwise, paying in cash may be the more sensible option. However, it is not advisable to use cash to cover your home improvement costs if doing so requires you liquidate your savings. Better to retain a cushion of savings for unexpected or emergency situations.
- Credit Cards. If you cannot pay cash for your home improvements, relying on credit cards should be an absolute last resort and reserved for emergency repairs only. If feasible, consider strategically combining the use of credit cards with the availability of cash by charging the cost of improvements to your credit cards to maximize rewards, then immediately paying off the balances to avoid paying interest. If you must maintain a balance month over month, consider you would be paying compound interest – interest calculated on the principal amount of debt incurred plus the accumulated interest of previous billing periods – versus simple interest which is calculated solely on the principal amount of debt incurred. If money must be borrowed, an extension of credit based on simple interest calculations is best.
- Investment or Retirement Accounts. Before liquidating any investment or retirement accounts to pay for home improvements, be sure to research penalties and fees that may result from a withdrawal along with any tax implications. These factors need to be considered in addition to long-term consequences of liquidating such assets. It is advisable you speak with your investment advisor and your CPA about the pros and cons of using such funds for home improvements.
- Consumer Financing. While the convenience of using consuming financing offered by remodelers and others in the trades is tempting, step back and take a mile-high view before you tap the “submit” button on your credit application. Many contractors offer short-term financing in the form of consumer loans. Getting a quick answer on your credit application and access to funds instantly is appealing. These loans are typically extended for six (6) to eighteen (18) months and generally limited in terms of the amount you can borrow. If you are planning a minor project, these loans may be worth a look. But if your project is large in scope or will require the use of multiple contractors, you may be better served by other financing options.
For example, if you need a new roof, HVAC system, and updated flooring and you plan to hire three (3) separate contractors to perform this work, each of them may offer their own consumer financing. By applying with each contractor, you would be taking on three (3) new loans that need to be repaid over short periods of time. Those payments can add up quickly!
- Cash-Out Refinances. A cash-out refinance may be a strategic way to pay for home improvements, depending on how much equity is in your home. If a first lien mortgage already exists, you’ll be required to pay it off with your new loan. You may only borrow against the current, or as-is, value of your home and you will be required to preserve some of your home’s equity. Conventional and FHA mortgages allow you to finance up to 80% of your home’s value on a cash-out refinance. VA allows you to finance up to 90% of your home’s value using a refinance option that allows cash in hand at closing. Alternative options may be available using non-traditional (a.k.a. non-QM) loans. In addition to making home improvements, proceeds of your new loan may also be used for debt consolidation or other purposes.
- Home Equity Lines of Credit (a.k.a. HELOC). You might explore the versatility of a HELOC (pronounced HEE lock). A HELOC is a line of credit extended by using the equity in your home as collateral. You can use the proceeds of the loan for home improvements, debt consolidation, or other purposes. If you have an existing first lien mortgage, you can leave it in place and take out a HELOC as a second mortgage against your property. This is an attractive option for those with low interest rate first mortgages, but it comes with limitations. As with cash-out refinances, you may only borrow against your home’s current, or as-is, value. Unlike other mortgages, you can pay off or pay down your HELOC and re-use it without applying for a new loan. Loan terms vary widely from lender to lender, and some lenders will allow you to finance up to 100% of your home’s value. During the draw period, your monthly payments will be based only on the interest accrued which makes this loan a good fit for those with the self-disciple to pay down the principal balance without being prompted to do so through monthly billing.
- Renovation Mortgages. Most homeowners do not realize renovation mortgages exist, allowing them to refinance their existing mortgage and include additional costs for home improvements. Before you execute another strategy, these loans are worth a look. A variety of renovation mortgages are available: conventional, FHA, USDA, VA, and even some portfolio programs. The proceeds of these loans may only be used to renovate your home. You select your own contractor. Your contractor provides a bid detailing the scope of work which is then given to the appraiser. The appraiser uses your contractor’s bid to estimate what your home will be worth after the renovation has been completed, allowing you to borrow against the future value of your home. Unlike a cash-out refinance, you are not limited to borrowing up to only 80% of your home’s value. With these flexibilities, you can borrow much more, stretching your renovation budget.
Leveraging your home’s equity to finance improvements has its advantages. Interest paid on mortgages may be tax deductible (Consult with your tax professional). Since the costs are amortized over a sizable period of time, absorbing the costs for home improvements becomes more affordable. And oftentimes mortgages provide lower interest rates and overall costs as opposed to using alternative methods of financing such as credit cards or consumer financing.
Jennifer Goldsby, NMLS #591226 | VP, Renovation Lending
Diamond Residential Mortgage Corporation NMLS #186805 | Equal Housing Opportunity
Disclaimer: The postings here reflect my personal opinion. They do not necessarily represent the opinions of Diamond Residential Mortgage Corporation and its management.
