Homeowners planning a remodel or home improvement project should carefully consider how they'll finance the work. Many payment and financing options exist and the one that suits you best depends on many factors, including:
Below are the most common methods of paying for home improvements, such as paying cash or taking out a loan, including which options work best for which people.
Some homeowners save up enough cash to pay for a home improvement project outright. By avoiding financing altogether, you don't pay finance charges or interest, which can save a bundle of money. In addition, because you don't use your home as collateral for paying back a loan, you don't risk losing your home to foreclosure.
If your project will cost anywhere from a few hundred to a few thousand dollars, you might consider paying with a credit card. Credit card interest rates are often quite high, but you won't pay any loan fees or closing costs. However, you should use this option only if you can pay off the entire balance in several months.
With an unsecured personal loan, you borrow money without using your home as collateral. So, if you fail to pay, your home isn't at risk of foreclosure. Some lucky homeowners can get personal loans from family members. Banks offer unsecured personal loans as well, but usually for small sums of money (for example, under $10,000). Beware of payday loans or personal loans offered by non-banks because many have exorbitant interest rates. These lenders also sometimes charge high origination and other fees.
A home equity loan is a loan that uses your house as collateral, just like your primary mortgage. With a home equity loan, you borrow against the value of your home less the amount of the existing mortgage (in other words, the equity). The borrowed amount is fixed, which makes it a good option if you're financing a one-time project. The interest rate is also fixed, which can be advantageous if you think interest rates will rise over the life of the loan. Another plus: The interest you pay on a home equity loan used for home improvements could be tax-deductible.
Before 2018, you could deduct the interest on up to $100,000 in home equity loans or HELOCs (see below). You could use the money for any purpose and still get the deduction—for example, homeowners could deduct the interest on home equity loans used to pay off their credit cards or help pay for their children's college education. The Tax Cuts and Jobs Act eliminated this special $100,000 home equity loan deduction for 2018 through 2025. However, the interest you pay on a home equity loan or HELOC used to purchase, build, or improve your main or second home remains deductible. The loan must be secured by your main home or second home. So, for instance, you can deduct the interest on a home equity loan you use to add a room to your home or make other improvements, subject to the limit on the home mortgage interest deduction.
With many home equity loans, you'll have to pay closing costs. And, as with any loan secured by your home, you risk foreclosure if you can't make the payments.
Like a home equity loan, a home equity line of credit (HELOC) uses your home as collateral to guarantee payment. A HELOC functions like a revolving line of credit; you can withdraw various amounts of money over time up to a specific maximum. The maximum you can withdraw is based upon the available equity in your home.
HELOCs work well if you have a long-term project or will need funds for additional home improvements in the future. The interest rate for a HELOC is usually variable, which means it can start low but climb higher if the prime rate rises. Like home equity loans, the interest you pay on a HELOC is sometimes tax-deductible. Note that you may deduct mortgage interest of any type only if you itemize your personal deductions on IRS Schedule A. If you don't itemize, the home equity loan and HELOC interest deduction won't benefit you.
Some employer 401(k) plans allow you to borrow money to pay for home improvements. Rates are usually low and you don't have to pay fees or qualify for a loan.
But if you leave your job you'll have to pay the balance in full or pay large withdrawal penalties and taxes. You'll also be on the hook for penalties and taxes if you don't pay the full sum within five years. In addition, experts warn that, although you pay the loan back to the account, when all is said and done you'll have less in your retirement account than if you hadn't withdrawn the money.
Title 1 loans are offered by banks but insured by the federal government. They're meant to help you finance light-to-moderate rehabilitation projects on a property or the construction of nonresidential buildings. Like home equity loans and HELOCs, you use your home as collateral and pay interest and closing costs. However, the difference is that Title 1 loans don't require that the homeowner have equity in the home.
Some limits apply to this program—you can't get a Title 1 loan for nonessential, luxury items (like swimming pools) and the maximum loan amount for a single-family home is $25,000 (2021). To learn more about Title 1 loans, including how to find a lender that offers Title 1 loans, visit the Title 1 page of the U.S. Department of Housing and Urban Development's website.
Another option for funding a home improvement project is to refinance your original mortgage for a larger amount and get the difference back in cash. As with any home loan, you'll pay closing costs and fees.
This option might be attractive if you have a large project, home prices are rising, and interest rates are low.
Most experts warn against getting financing from your contractor or using a lender recommended by your contractor. Some shady contractors get deals from subprime lenders that are loaded with hidden costs and fees. It's best to negotiate the project's price with your contractor and then get financing on your own.