Imagine what you’d do with more space or updated features in your home — a new master bathroom, a renovated kitchen or a spacious home. Now for the reality check: Figure out how you’ll pay for it.
There are many options available to homeowners who want to spruce up or increase the square footage of their home. Understanding the various choices can help you make a decision that’s as good for your pocketbook as the renovation is for your house.
Read on for 9 possible sources of extra cash for home improvement, as well as the pros and cons of each.
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Major credit cards
If you have a smaller project — or a great introductory offer, like 0% interest for a year — credit cards can be a good option. With some cards, you may earn rewards or cash back valued at a few percentage points of the total amount that you spend.
The downside of this option is that if you can’t pay the cards back in a timely fashion, you’ll owe interest that far outweighs the perks. And because rates are variable, you may end up being hit with even higher monthly payments than you planned.
Pros: No paperwork needed for established credit lines; also, there is a possibility of cash back or other rewards.
Cons: There is a possibility of high interest rates; variable rates mean you could pay more over time.
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Store credit cards
Cards from home improvement stores like Home Depot and Lowe’s can be a good option if you know you can pay off the balance fairly quickly. Many cards provide an introductory offer with no interest for a set period of time, while others provide periodic specials on a range of products.
Like traditional credit cards, you want to make sure you can pay off the balance in a timely manner to avoid high interest payments. Watch out for expiring introductory offers — if you don’t pay off the balance in full by the time the offer ends, you’ll generally be hit with all of the back interest, as though you never got the offer at all.
Pros: These cards offer the same pros as major cards and occasionally offer specific bargains for home improvement buys.
Cons: Cards can only be used at a single chain of stores.
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Home equity line of credit
A HELOC, or home equity line of credit, is a bit like a credit card. The main difference is that the line of credit is secured with your home. If you don’t pay on time, there’s a chance that you may lose your home.
The rates are variable and often will start with a very favorable rate and adjust upward.
A HELOC generally doesn’t require as much paperwork as a full refinance or a second mortgage, and in most cases you can take a tax deduction on interest.
Finally, a HELOC may be a good option for remodeling in stages. “You only pay interest on the amounts you borrow on the HELOC,” says Matt Coffin, founder of Coffin Capital. “If you don’t use the line of credit, you don’t have any monthly payments to make.” You can also use it again and again, borrowing money, paying it off and borrowing again.
Pros: HELOCs may have lower interest rates than credit cards, and can offer tax benefits.
Cons: Collateral is required in order to sign up; variable rates can climb.
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Home equity loan
A home equity loan is a second mortgage — it offers a fixed rate, but it typically has a higher rate than it would be for a first mortgage or refinance.
On the other hand, there usually isn’t nearly the amount of paperwork involved as there is for a full refinance.
“There’s a lot less documentation for a second mortgage,” says Lance Melber, CEO at Valutrust Solutions LLC. Often, homeowners can get approved the same day, and an appraisal can (frequently) be done online.” Like a refinance and a HELOC, you may be able to take a tax deduction on the interest.
A home equity loan also may be appropriate if you want a fixed rate but have a great interest rate on the first mortgage. With this type of loan, you can continue to pay off your first mortgage at the low rate and just tack on a second payment.
Pros: A home equity loan is less complicated than a full refinance, less expensive than a line of credit and can offer tax benefits.
Cons: These loans tend to have a higher interest rate than full refinances.
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There are a few reasons why you may want to consider a full refinancing of your home to finance your remodeling project — even though it will require some significant paperwork and often quite a few upfront costs. If you’ve got a major home improvement project to take on and have built up significant equity, refinancing and taking cash out might make sense.
If someone currently has a high interest rate on their home, it may make sense to refinance rather than get a higher-risk, higher-rate second mortgage. As with any mortgage, you may qualify for tax deductions on your mortgage interest.
Pros: Refinancing can likely get you the lowest interest rate available and is good for those looking to do substantial remodeling; also offers tax benefits.
Cons: Refinancing can be complicated and is initially costly.
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Title I loan
Title I is a government program that helps make home improvement loans more affordable for consumers by insuring lenders against losses on those loans. The improvement must be light or moderate, and the loan cannot exceed $25,000 on single-family residences. (Other limits apply to different structures.) Title I allows lenders to provide funding to homeowners who have minimal or no equity in their homes. That is, an owner’s total loans would exceed the value of the house. Upfront costs usually amount to 1% of the loan. The Department of Housing and Urban Development offers online help in finding a lender for Title I loans.
Pros: A Title I loan is a good option for those with little or no equity in their homes.
Cons: Your remodeling must fit certain requirements.
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401(k) or IRA loan
If you’ve got money in a 401(k) or a traditional IRA, it may be tempting to raid the account to help finance those home improvements. But, unless you’re old enough to take distributions (59 1/2), try to make sure you’ve exhausted all of your other options first.
In some ways, borrowing seems like a good deal. Because you’re borrowing money from yourself and paying the principal and interest back to yourself, you benefit, right? Not really. First of all, if you don’t pay the money back within a specified period of time, you’ll be hit with a 10% penalty. And if you leave the job that’s providing the 401(k), you’ll need to pay back the loan in a short time or face penalties. You’re also losing out on the money you’d otherwise be earning if it were in the account.
Pros: Borrowing from a 401(k) or IRA is an option if no other options are available.
Cons: Borrowing from a 401(k) or IRA can have possible tax consequences and result in long-term losses in retirement funds.
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Life insurance borrowing
If you’ve got a cash-value life insurance policy, 1 of its benefits is your ability to borrow up to the policy’s cash value (but not the earnings). Not only that, there’s no set repayment schedule or even a required monthly payment.
That said, there are drawbacks. You’re not actually borrowing from yourself; you’re borrowing from the insurer. The cash value serves as collateral (an important technicality). Your loan balance could end up growing faster than the cash value of the policy if you don’t pay it back. Even worse, if the amount that you owe exceeds the cash value, you’ll get a bill to pay the difference, and you may face tax consequences.
Like borrowing from your retirement, this is an option you should exercise as a last resort, not your first.
Pros: There is no set repayment schedule; you can borrow up to the cash value of the policy.
Cons: There are possible tax consequences, and your payments could eat into the collateral.
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Private loans can be had from any number of sources, including the contractors who do your improvements or even the stores from which you bought the supplies to do it yourself. These unsecured loans often have higher interest rates and fees, but it’s also often fast and simple to get approved.
You won’t be able to deduct any of the interest from the loan on your taxes, as you can with a variety of home loans and lines of credit.
Pros: Private loans boast fast approval times.
Cons: These loans have higher interest rates and fees.