Need to finance your home renovations? Renovating still happens—even during a recession.
How can I finance my home renovations? Ah, the age-old question we at Sweeten get all the time. Luckily, Sweeten has translated insight from renovators and contractors into information you can use to make better decisions about improving your home. In the current economic climate, renovators can take advantage of low-interest rates to finance their projects. Loan rates are relative to the prime rate, which is 3.25% as of September 9, 2020, whereas in August 2019, for example, it was 5.25%. Read on to learn more about how to finance home renovations in 2020.
Sweeten matches home renovation projects with vetted general contractors, offering advice, support, and financial protection—at no cost to the homeowner. Here’s a look at options for paying for a major home renovation.
1. Pay in cash
Regardless of low interest rates, paying in cash is the most straightforward way to go. If you’re paying cash (and even if you don’t), lay out a clear payment plan with your contractor to avoid surprises.
Most projects require a deposit upfront with installments at various points over the duration of the project. You might see terms on a smaller project for two payments, with 50% due up front and 50% due at completion. For a straightforward project like a kitchen or bathroom renovation, you might agree to pay 15% to 30% upfront, 40% to 50% at the midway point, and the final 15% to 30% upon completion.
Larger projects tend to require less upfront but more payments along the way. You can expect to peg payments to milestones like demolition, midway project completion, and punch-list completion. Work with your general contractor to agree to these terms and put it all in writing!
Do note that some general contractors will accept credit card payments. Not all contractors will take this form of payment, but it’s worth asking (and think of the points you’ll earn!), as it can help you stretch the payments over the course of a few months.
If you feel confident about your ability to pay on time, you might also look into opening a zero-interest credit card. Be aware that these cards typically have very high interest rates that kick in if you don’t pay off the balance by the end of the zero-interest period (usually twelve months), but they can be a tool in spreading out payments beyond the duration of the project.
2. Take out a personal or unsecured loan
If you anticipate that your renovation will come in under $50,000, you might consider a personal (or “unsecured”) loan from a credit union, bank, or another lender. These loans do not require collateral (meaning that the loan isn’t tied to your home and won’t jeopardize it if you default) and are usually fairly easy to acquire.
Personal loans offer higher funding amounts than credit cards do, but less than a home loan would provide. These loans tend to be offered for a fixed term at a fixed interest rate and are repaid in monthly installments. The downside, of course, is that the interest rates on these types of loans tend to be much higher than on loans associated with your home (like mortgages with built-in renovation financing, home equity loans, or home equity lines of credit).
Expect to pay interest in the range of 6.5% on a $50,000 loan over 24 months (by comparison, mortgage rates currently hover around 3% for a 30-year fixed mortgage). Rates tend to vary quite a bit for personal loans, so do your research to see what makes the most sense for your renovation.
3. Build financing into your mortgage
If you are currently in the process of purchasing a home, this might be the way to go. And if you already own but are considering refinancing, this option can help you adjust your mortgage rate and simultaneously roll new financing into it (a process known as “cash-out refinancing”). Either way, you go through both the mortgage and renovation financing application process once and you’ll end up with one monthly payment for both.
Home’s future value
Your lender will likely calculate the amount of the loan based on the future value of the renovated property. Why is this a benefit? Well, you can borrow more because you may qualify for a larger loan than you might if the calculation were based on the home’s pre-renovation value. This also tends to mean that you don’t have to worry about the current condition of the home; with some other types of financing, the lender may balk if the property is in disarray.
Types of mortgages
As with regular mortgages, you can choose between a conventional loan and one backed by the Federal Housing Administration (FHA), known as a FHA 203(k) loan. 203(k) loans have more lenient guidelines and allow the homeowner to borrow a higher percentage of the home’s current value. With either a conventional or FHA mortgage, your monthly payments may be lower than they would be with a home equity loan or line of credit (both detailed below). They will be slightly higher than a regular mortgage, but still lower than a home equity loan or a line of credit. These loans are also attractive because you are locking in your rate so payments will not unexpectedly fluctuate.
Note that built-in loans may have requirements regarding the timing of your renovation, however. They may require that you begin and complete your renovation within a set window after closing, and they may stipulate that work cannot stop for more than a set period of time. So, these loans are not well suited for future renovations or work that might take place at different stages.
Lastly, note that these loans take 60-90 days from beginning to finish, because they require more legwork up front, you need to have mostly finalized your construction plans first, because the appraiser needs to review them to assess the post-renovation value of your home.
4. Take out a home equity loan (HEL)
A home equity loan is often referred to as a “second mortgage,” and is an option if your home is worth more than what you now owe on your mortgage. This type of loan is similar to a conventional mortgage in two ways. Firstly, it offers tax deductions on interest payments. Secondly, you make payments over the course of a long period of time. Take note: there may be closing costs involved, and while the interest rate is usually fixed, the rate is somewhat higher than conventional mortgages.
However, due to the low prime rate currently, you’ll still get a better rate than you would have in years past. In addition, sometimes lenders charge a penalty if you pay off the loan early, so be sure to look closely at the terms.
5. Establish a home equity line of credit (HELOC)
A home equity line of credit is similar to a credit card. The lender gives you a credit limit and charges you interest on the amount you use. Instead of receiving a lump sum upfront, you borrow what you want, when you want. This makes it a good option for a series of projects, or if you anticipate that your renovation will be lengthy. You can obtain these types of loans from all the usual suspects—banks, finance companies, brokerages, and credit unions.
Interest rates are adjustable, so beware of loans with low initial rates. Some may also have a minimum withdraw, and many offer 5-10 years of access to the credit line. While the credit line is open, you pay interest on what you owe, and then you typically have 10-15 years after it closes to pay it back in full. Compared with home equity loans, a home equity line of credit offers more flexibility. However, since the rate fluctuates, it is also riskier. Terms and conditions vary widely on credit lines, interest rates, and fees, so it’s important to read the fine print.
How did you finance your home renovations?
Now that you know how to finance your own home renovations, we want to hear from you! Have you paid for a renovation project with one of these options (or in an unconventional or particularly resourceful fashion?) Let us know in the comments!
If you’re deciding on your scope, here’s where you might splurge and save from kitchens and bathrooms to basements.
Sweeten handpicks the best general contractors to match each project’s location, budget, scope, and style. Follow the blog, Sweeten Stories, for renovation ideas and inspiration and when you’re ready to renovate, start your renovation with Sweeten.