Step 2: Paying for your home renovation

Paying for a home renovation can be a challenge. Of course, the ideal situation is to be able to pay cash for your project. But if you haven’t been able to set aside money for the full cost of your renovation, there are many loan options available to help you finance your project.

1. Refinance your mortgage and take cash out

If you have equity built up in your home, you can do a cash out refinance on your first mortgage. You can do this by refinancing your home loan for more than the current balance and take cash out to pay for your home renovation. Depending on how you structure your loan, you may even be able to keep your monthly mortgage payment the same by extending the term of the loan. Cash-out refinancing may also allow you to pay a lower interest rate than with a home equity loan or line of credit. The drawback is that if you choose to extend the term of your loan, your interest costs will increase. If your home addition involves making structural changes to your home, your lender may approve your loan amount based on the estimated value of the home once the home renovation is completed.

2. Home equity loan

A home equity loan works like a conventional first mortgage and can be a good option for paying for a home renovation. Using your home to secure the loan, you borrow a lump sum that you pay off for several years. The interest rate for a home equity loan typically remains fixed, but the interest rate is generally higher than that of a first mortgage. However, your closing costs are lower than with a first mortgage. With a home equity loan, you get all of the money you are borrowing at once, which can be good if you must pay a large, upfront sum to your contractor.

3. Home equity line of credit

A home equity line of credit is another option for paying for a home renovation. This is a good option if you need to pay in stages. A home equity line of credit (HELOC) works like this: a lender approves you to borrow up to a certain amount of money. You access the money as needed through a checkbook tied to your loan account. (This can make it very easy to pay different contractors or to make your purchases at a home improvement store.) You owe interest only on what you have borrowed, and you can choose how much to pay each month. Because of this, payments on a HELOC can be lower because you can choose the interest-only payment. However, the total loan amount will come due in several years, and if you haven’t paid down your principal, you will either need to have the cash on hand to pay off the loan or you’ll need to refinance the loan. HELOCs usually have adjustable interest rates, which means you need to watch your rate carefully in a rising interest rate environment. HELOCs can be a good way to pay for smaller projects.

Personal loan or line of credit

If your project is small, you may consider a personal loan or personal line of credit. Although they typically have lower fees, these loans are not secured against your home so they usually have higher interest rates than home equity loans or lines of credit. Also, whereas the other options are usually tax deductible, a personal loan or line of credit is not.

Once you have decided which type of financing works best for you, get preapproved from a lender so you know what you can afford. And make sure that your budget is at least ten percent less than your maximum loan amount. This gives you additional money to cover any unbudgeted costs during your home renovation.


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