Americans spend more than $400 billion a year on home renovations and repairs, with a median project cost of just $1,200. For 77 percent of these projects, homeowners are able to pay for them using cash from savings. But for more expensive renovations and remodels, financing a home improvement is a necessity.
Fortunately, homeowners have a lot of choices here, and many of them come with favorable interest rates. But wading through the options is a lot less fun planning the remodel itself. If your savings won’t cover the cost of your project, here are some of your best options.
Financing options at a glance
| Cash-out refinance | Home equity | HELOC | FHA 203(k) | Personal loans | |
Average interest rates* | 3.22% | 5.11% | 4.55% | 2.91% | N/A |
Minimum loan amount | N/A | $10,000 | $25,000 (line of credit) | $5,000 | N/A |
Average loan amount** | $7,500 | $9,300 | $9,300 | N/A | N/A |
Minimum FICO® score | None | 620 | 620 | 580 | N/A |
Closing costs | 3% to 6% | 2% to 5% | 2% to 5% | ~2.5% | 1% to 8% |
Fixed or variable rates | Fixed | Fixed | Variable | Both | Both |
*Based on data from Bankrate.com, Updated October 9, 2020
**Based on data from the Joint Center for Housing Studies of Harvard University
What kind of loan is right for me when financing a home improvement project?
The loan that’s best for your remodel depends on a lot of personal factors. Did you purchase your home when interest rates were higher? How much of your mortgage have you already paid off? Are you looking at a one-time expense or an ongoing project?
In general, most experts recommend a cash-out refinance, home equity loan, or HELOC for financing a home remodel. But if you’re thinking about purchasing a fixer upper, an FHA 203(k) is probably the way to go.
Cash-out refinance
| Pros | Cons |
Could lower interest rate on mortgage | Closing costs are usually 2 to 5 percent of the mortgage |
Provides the option to take out larger loans | Risky for people with a lot left on their mortgage |
Typically offers lower interest rates than home equity and HELOC | Longer closing times |
Who it’s for: Anyone who purchased their home at a higher interest rate and has a substantial amount paid off.
This route has all the benefits of a traditional mortgage refinance, with the added perk of cash for your renovation.
A cash-out refinance essentially adds the cost of your remodel to your existing mortgage. You then get the difference between the two mortgages in cash. This is different than a traditional refinancing, which simply replaces your existing mortgage with the same amount at a lower interest rate.
Like a home equity loan, banks will typically lend around 80 percent of your home’s value in a cash-out refinance, minus what you still owe on your mortgage.
If you originally bought your home when mortgage rates were higher — they currently sit around 3 percent — a cash-out refinance will get you a lower interest rate in addition to providing the cash you need for your remodel. That said, it typically carries slightly higher rates than a straight refinancing because the lender is taking on extra risk.
It’s also not a good option if you purchased your home when interest rates were lower, as refinancing will lock you into current rates.
Home equity loans
| Pros | Cons |
Quicker close times than cash-out refinance | Closing costs are usually 2 to 5 percent of loan |
Fixed rates for predictable payments | Risky for homeowners who have a lot left on their mortgage |
Receive lump sum payment | Not as flexible as HELOC |
Who it’s for: Anyone who has a fixed budget for their remodel and wants to keep the low rate on their existing mortgage.
A home equity loan is a second mortgage that uses the value you’ve already invested in your house to let you take out more money. Most lenders allow you to borrow around 80 percent of your home’s value, minus what you owe on your mortgage.
The more you’ve paid off on your mortgage, the bigger loan you can take out. Unlike a refinance, a home equity loan creates an entirely new mortgage.
The downside is that interest rates tend to be higher for home equity loans. Bankrate, a financial services company that tracks interest rates, currently estimates that interest rates for home equity loans are around 6 percent on average, while mortgage refinance rates are less than 4 percent for a 30-year fixed-rate mortgage.
Home equity line of credit (HELOC)
| Pros | Cons |
Can withdraw money gradually as needed | Vulnerable to rising interest rates |
Better interest rates than credit cards or personal loans | Risk of overspending |
Who it’s for: Homeowners who have ongoing renovation costs over a number of years.
Like a home equity loan, a HELOC is a second mortgage that gives you money based on the value of your home — again, up to 80% of your home’s value, minus what you still owe.
But while a home equity loan gives you the money you need all at once, a HELOC is more like a credit card: You have a set amount of money available to use as you need it.
HELOCs are divided into two phases: a draw period and a repayment period. During the draw period — usually around 10 years — you use the line of credit as needed and are only responsible for paying the interest.
After this period ends, both the principal and interest are due every month. This repayment phase typically lasts 15 to 20 years.
FHA 203(k) loans
| Pros | Cons |
Builds cost of repairs into mortgage | Must use FHA-approved lender |
Only requires 3.5 percent down payment | Complicated paperwork |
Relatively low interest rates |
Who it’s for: Prospective buyers looking at a fixer upper or homeowners with little or no home equity.
Often called a “rehab mortgage,” an FHA 203(k) is designed for home buyers looking to finance a fixer-upper. The loan is based on the future value of your home after its renovations (as opposed to a home equity loan, HELOC, or refinance, which are based on its current value).
Because 203(k) loans are backed by the federal government, there are some stipulations. The house must be your primary residence, you’ll need to hire a licensed contractor, and you can’t finance anything the FHA considers “luxury” — a list that includes “tennis courts, gazebos, or new swimming pools.”
The amount you can borrow is also limited to 110 percent of the home’s projected value (as determined by an appraiser) or the purchase price plus repair costs, whichever is less.
For example, if a $60,000 kitchen remodel adds on $40,000 of value to a house you purchased for $200,000, you’d be limited to a 203(k) loan of $240,000. Because of that limitation, these loans should be reserved for renovations that add serious resale value.
While most people use 203(k) loans to buy a home, they can also be used to refinance as long as you have at least $5,000 in improvements to make.
Personal loans
| Pros | Cons |
Home is not used as collateral | Requires good to excellent credit |
Usually a quicker turnaround | Typically higher interest rates |
Shorter loan periods |
Who it’s for: Homeowners with good credit but not much home equity.
Often called “signature loans” or “unsecured loans,” a personal loan is a great alternative if you don’t have a lot of equity in your home built up.
They are also one of the fastest ways to procure financing. Online applications only take a few minutes, and you can usually get the funds within a couple days.
That said, interest rates will likely be higher for many people. Because the loan isn’t guaranteed by your house, rates will depend entirely on your credit history. Bankrate’s average personal loan rates range anywhere from 5 to 36 percent, depending on factors like credit score, income, and debt ratio.
Other options to financing a home improvement
Credit cards
Plastic should be reserved for purchases that you can pay back in a short period of time, as interest rates are substantially higher than the financing options listed above. On the plus side, choosing a credit card with rewards tied to home improvement purchases could help offset some of the costs.
Borrowing from your 401(k)
While most financial planning experts view 401(k) loans as an act of self-robbery, it can be a viable option for short-term expenses. You’re able to “borrow” half the money in your 401(k), up to a maximum of $50,000 on a tax-free basis. You’ll only have five years to return the money to your account, you’ll still need to pay interest back into your 401(k) — essentially moving money from one pocket to another.
That said, it does come with significant risks. According to a recent Deloitte study, 10 percent of people who take out 401(k) loans default on them. If you leave your job or get laid off while you have a 401(k) loan, the outstanding balance has to be paid back before the due date of your federal income tax return — a risky proposition for many people.
Asking your contractor for a loan
Some contractors may offer short-term loans for financing a home improvement projects — typically financed by third-party lenders. If you go this route, Consumer Reports recommends asking past clients about their experience with the contractor and checking with your state’s office of consumer affairs and the Better Business Bureau. Additionally, make sure your contract includes the right to withhold payments if the work doesn’t meet your agreed-upon standards.
Remember to shop around
Interest rates are highly personal. Factors like credit score, home location and loan size all go into determining your interest rates, and each lender weighs them a little differently. To get the best rates, we recommend comparing quotes from a few different sources before financing a home improvement project
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