7 ways to finance your home remodeling project

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With travel plans largely in limbo over the past 18 months and many Americans still unsure about making the journey, some have turned their attention instead to improving the homes where they increasingly spend their time . Renovating your home can not only make it more comfortable to stay indoors, but also increase the value of the home and turn into a profitable investment in the long run.

But it is a decision-intensive process. It involves making a decision about the renovation project itself, followed by a decision about the level of costs and, if necessary, financing.

The prices for a well-done project can be high. However, a renovation can be accomplished with several financing options, including savings, a home equity line of credit (HELOC), a home loan, and credit cards.

“The sweet spot for the kitchen [renovations] is typically about 10 percent of the sticker price for a home, and for bathrooms it’s about half that,” said Mischa Fisher, chief economist at Angi, a home services platform. “For an average US home worth about $350,000, you’ll get the best return on investment with a kitchen remodel of about $35,000 and a bathroom remodel of about $17,000.”

Angi, formerly known as Angie’s List, has released its 2021 True Cost Report showing a typical range of bathroom remodeling costs from $6,590 to $16,359 and a range of kitchen remodels from $13,490 to $38,043. You can also enter your zip code for a localized estimate.

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Unless you’ve amassed significant savings, a five-figure home renovation means taking out a loan. Luckily, there’s no shortage of ways to borrow money to make that dream project a reality. From home loans to personal loans, cash-out refinance, a HELOC, 401(k) loan, and even credit cards, there’s almost certainly a way for a motivated homeowner to get financing for their project.

Whether this renovation makes financial sense and which borrowing option is best depends on a variety of factors, including the cost of the home, the cost of the project, the owner’s creditworthiness, familiarity with building, risk tolerance, and trust in the community Market.

Soaring real estate prices mean that most homeowners have a good chunk of equity. The downside is that selling to move to a larger or better located property can still be out of reach as these properties have also risen in price, making renovating where you already live potentially more enticing.

“Consumers feel cornered,” said Patrick Walsh, senior vice president at Tandem Bank in Atlanta. “The market is currently so competitive for new products as well as for resale, I’m sure many consumers feel that refurbishment is their only option. The downside of this is high timber prices and other issues that make the projects less viable than they otherwise would be.”

Nevertheless, a tastefully executed renovation can bring a nice return. In addition to the universally popular kitchens and bathrooms, improving visibility always helps.

“The best payoffs tend to be big visual changes for a modest price, things like exterior projects with appeal,” Fisher said. “If your siding is in poor condition, you should repair or replace it. It could cost you as much as $10,000 upfront, but it probably recoups 80 percent or more of that cost — not to mention it’s a great first impression for potential buyers.”

Regardless of the project, Fisher recommends interviewing multiple contractors and obtaining at least three estimates before proceeding.

Perhaps the easiest way to finance a renovation is to pay with savings, if possible. There is no interest to pay back and no paperwork to fill out. Even so, homeowners should be careful to select a project that yields the best return on investment, and perhaps think twice about tapping into home renovation savings.

With interest rates often at or below 3 percent, it may make more financial sense to take out a loan and invest those savings elsewhere. The Federal Reserve has said it will raise interest rates soon, which would mean historically low mortgage rates would also rise.

“If you have someone who is confident they can get a better than 3.5 percent return by investing their savings, I would encourage them to at least discuss the opportunity cost of using that money,” Walsh said. “If you’re paying off debt at 3.5 percent when you could get a 6 percent return, you might be better off using some of that money for something else.”

Products such as a Federal Housing Administration 203(k) or Fannie Mae HomeStyle Renovation Loan may be awarded based on a home’s expected higher future value after renovation. However, they are not easy to use and usually contain tricky terms.

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“FHA 203(k) and Fannie Mae-type home loans are expensive,” said Erika Safran, director of Safran Wealth Advisors in Manhattan. “They are highly regulated and funds are released to your contractor based on the stage of construction.”

Safran adds that home loans can also include personal mortgage insurance, and there are ongoing assessments and appraisal costs throughout the project. She advises anyone who takes out a construction loan to convert to a classic mortgage once the renovation project is complete.

For homeowners who want to borrow a relatively small amount, a personal loan might make sense because the upfront costs are lower and it is repaid more quickly than a full refinance.

Personal loans are typically repaid within six or seven years, and while the interest rates are higher than a HELOC or mortgage, they’re usually lower than a credit card.

Mortgage refinancing has long been a popular option for homeowners, whether they’re renovating or not. The reason? Interest rates have been falling for decades.

“I’ve been saying for 20 years that interest rates are at their lowest ever,” said Jennifer Adams, vice president of mortgages at GuardHill Financial Corp. in NYC. “We are in a constant refinancing boom.”

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A cash-out refinance means replacing the existing mortgage with an entirely new one. If the payoff loan is used to pay for renovations, there will be a higher amount than the original loan. With interest rates so low right now, the homeowner could still end up with a lower total payment in hindsight, albeit for a longer loan term.

Payout refinancing also means the money goes to the homeowner and not contractors, making it more flexible than a home loan.

home equity line of credit

A HELOC is a good option for those with enough equity, which many homeowners are these days thanks to recent appreciation in value.

While closing costs and payments are low, those initial payments only earn interest. Homeowners can also claim the interest paid for tax purposes. Safran said it’s important for people to fully understand the terms of a HELOC before signing.

“Consumers can mistakenly choose a HELOC because of a low payment, unaware that the minimum payment only covers interest,” she said. “To fully repay the loan within five years, homeowners should pay both principal and interest.”

Borrowing against your home’s equity can also be risky when prices fall again, as they did during the Great Recession. Walsh said Tandem Bank will allow homeowners to borrow up to 80 percent of their home’s value with a HELOC, but some lenders are going as high as 95 percent.

Borrowing against your retirement savings can be a quick way to get cash, and you pay the interest to yourself rather than to an outside lender. Borrowers can typically borrow up to $50,000, or 50 percent of the balance.

But as with using personal savings, Walsh cautions consumers against taking money out of their 401(k) invested in stocks and bonds and using it to invest in a home renovation.

“If you’re just using it as a loophole to finish the house and then putting it into permanent debt, that could be a viable option,” he said. “But what is the long-term opportunity cost of pulling that money out of your pocket? [stock] Market? I don’t think you would get the same return on real estate over the long run that you would get from the 401(k).

Most financial advisors do not recommend using a 401(k) loan unless no other funding is available.

Another option that financial advisors sometimes advise against is using a credit card. A disciplined borrower can open a new card and take advantage of interest-free periods of six or 12 months to borrow money for free. But if this plan does not work, the borrower will be charged interest of up to 20 percent and more.

“It’s a really expensive way to do a renovation,” Adams said of using credit cards for renovations. “It can be a very slippery slope.”

While credit cards have the highest rates, there are no additional upfront or closing costs, and if the debt is paid off in a year or two, you can complete the project without adding long-term debt.

For these reasons, Safran encourages the use of credit cards in certain circumstances.

“If it’s a project small enough to pay off with a card within a year, pay it off,” she said. “Done and done.”

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