By Annie Millerbernd
One major perk of homeownership is the ability to remodel your home. You can gut the kitchen and add an island or turn your backyard into an outdoor oasis.
Deciding how to pay for home renovations is a core part of the process. Some homeowners turn to savings, while others choose to finance the project, often using home equity or a personal loan.
Most financial planners say the best financing option depends on your financial situation, including your income, credit and how much equity you have. Here are some questions to ask to help you choose the best option.
How Much Can You Borrow?
If you’re a new homeowner, you might not yet have enough equity in your home to borrow from, says Ryan Greiser, owner and certified financial planner at Opulus, a financial advisory firm based outside of Philadelphia.
Equity is the amount you owe on your home subtracted from its current value. Building it can take years, depending on how quickly you pay down your mortgage and how much your home value increases.
Lenders typically let you borrow up to about 80% of your equity with a home equity loan. If that number is lower than the cost of your renovation project, a home equity loan won’t cover it, and you’ll need to choose a nonequity option.
The amount you get with a personal loan, on the other hand, is often based solely on your creditworthiness and finances. Such home improvement loans are available in amounts up to $100,000, but you’ll need strong credit and low debt compared to your income to qualify for the largest loans.
Both personal and home equity loans come in lump sums, so having a solid estimate of your project’s cost before you apply is important. You can’t easily go back and borrow more if you misjudge.
How Quickly Do You Need the Funds?
You’ll wait longer to get the funds from a home equity loan than a personal loan.
Deka Dike, a wealth management banker with U.S. Bank, says a home equity loan takes three to six weeks from application to funding.
“Maybe three, four months into the pandemic we saw a lot of delays” because it was more difficult to conduct in-person appraisals, she says. “Now I think everything is back to normal; people are more comfortable.”
With a personal loan, you may be approved for a loan and receive the funds within a week. Some online lenders say they can fund a loan the business day after you’re approved.
The fast funding time makes personal loans ideal if you want to start your project immediately — or if you’ve already started. Dike says a home with a gutted kitchen can’t be appraised, so an application for equity financing submitted mid-project may not get approved until you’ve put your house back together.
Which Costs Less?
Home equity loans typically have lower monthly payments because their rates are lower than rates on personal loans, and they’re repaid over a longer period.
Home equity loan rates fluctuate between about 3% and 5%, while personal loan rates start around 6%. Rates on home equity loans are lower because they’re secured with your home, while personal loans don’t usually require collateral. With either loan, your credit score, income and the loan term factor into the rate you receive.
Both personal loans and home equity loans have fixed rates and payments, so you’ll know when you get the loan how much your monthly payment will be over the life of the loan.
Greiser says personal loans can work for homeowners who don’t want to use their equity or haven’t built up enough equity but do have enough cash flow to make the monthly payments.
Repayment terms are another factor in the loan’s affordability. You often repay a home equity loan over five to 15 years, while the typical personal loan term is two to seven years. Some personal loan lenders offer longer repayment terms of 12 to 15 years specifically for home improvement projects.
With a long repayment term, you get lower monthly payments, while a short repayment term reduces the total interest you pay. Use a home improvement loan calculator to see how much you’d pay on a loan based on the amount, interest rate and repayment term you choose.
Home equity and personal loans aren’t your only home improvement financing options. Here are a few other ways to pay for repairs and renovations.
Home equity lines of credit: Consider a HELOC if you have enough equity but are uncertain how much your renovation project will cost. With this type of financing, you borrow a certain amount but repay only what you use. Dike says HELOCs are one of the most popular ways her clients finance home updates.
Credit cards: Your credit card is best suited for DIY projects and smaller upgrades. If you have a store card with a retailer that you plan to use for renovation expenses, you could earn cash back. Be sure the purchases don’t put you too close to your credit limit and pay the balance in full each month to avoid paying interest.
Cash-out refinance: Cash-out refinance makes sense when current mortgage rates are lower than what you’re paying. You refinance your mortgage for a higher amount than you owe, and then “cash out” the rest to pay for the renovation. Cash-out refinance often comes with closing costs and requires an appraisal, so your timeline and budget should be pretty concrete before you choose this option.
Mix and match: You can split a project up between multiple types of financing, says Greiser. For example, you could pay for the bulk of the project with a personal loan, but use your credit card or savings to cover any unexpected costs. Just keep an eye on how much debt you take on overall.
“The last thing we want is people overleveraging themselves,” he says. “At the end of the day, everyone’s situation is different and we just like optionality.”
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Annie Millerbernd writes for NerdWallet. Email: email@example.com.