Demo Your Kitchen, Not Your Finances: Here’s How to Navigate Home Renovation Loan Options
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Gina Rodrigues Contributing AuthorClose
Gina Rodrigues Contributing AuthorGina is a freelance writer and editor who specializes in real estate and personal finance. She brings more than ten years of experience as a licensed agent and property investor. When she isn’t writing, she can be found tending to the sheep and chickens at her suburban homestead outside of Seattle. Gina holds a B.A. in English from California State University.
Disclaimer: As a friendly reminder, information in this blog post is meant to be used as a helpful guide for educational purposes only; it is not legal or professional financial advice. For guidance on your individual situation, please consult a skilled financial planner.
Maybe you’ve been binge-watching HGTV and want to remodel your kitchen. Or maybe you’re tempted to build an office add-on for your new remote job. Well, the average kitchen remodel can set you back between $10,000 to $100,000. And that 12 x 12 office addition? Prepare to fork over $32,000 to $80,000.
Whether you need funds for an emergency fix or a major design overhaul, lack of cash doesn’t have to stand in your way: You can borrow money to renovate your home.
We spoke with two financial advisors to get their take on borrowing money for a remodel. Nikki Dunn, a Certified Financial Planner (CFP®) and founder of She Talks Finance, reveals how your financial standing could impact your borrowing decision. R.J. Weiss, CFP® and founder of the personal finance site The Ways to Wealth, offers advice based on his personal experience financing his remodel.
Options for financing your home renovation project
There are many ways to borrow money to renovate your home. You can access your home equity through a federally-insured or private lender. Other financing options include unsecured personal loans, renovation loans, and credit cards.
There’s no one-size-fits-all solution: Each financing method comes with unique benefits and drawbacks. Below is an overview of the most common loan and credit options. For a more detailed overview, see our post on home renovation loans.
| Loan type | Loan description | Consider this option for | LTV limits | Other factors to note |
| Cash-out refinance | Fixed or adjustable-rate mortgage loan, often a 15- or 30-year term, that pays off your existing mortgage with a higher loan amount Lump-sum at closing to use at your discretion | Larger, extensive remodeling projects when you need a large lump sum | 80%-90%, depending on the lender | These loans use your home as collateral, usually at a lower interest rate than unsecured loan options. Funds used to remodel your home may be tax-deductible. |
| Home equity loan | Fixed-rate loan, commonly a second mortgage Lump sum at closing to use at your discretion | Most remodeling projects when you need one large lump sum | 85%-100%, depending on the lender | These loans use your home as collateral, usually at a lower interest rate than unsecured loan options. Funds used to remodel your home may be tax-deductible. |
| Home equity line of credit (HELOC) | Revolving line of credit that allows you to draw funds as you need it Predetermined time period to draw funds before loan payoff term begins Often has a variable interest rate | Most remodeling projects when you don’t need all of the funds upfront | 85%-100%, depending on the lender | According to Weiss, HELOCs have relatively low closing costs when compared to a traditional mortgage. Pay interest fees only on funds you draw. These loans use your home as collateral, usually at a lower interest rate than unsecured loan options. Funds used to remodel your home may be tax-deductible. |
| Fannie Mae HomeStyle® renovation loan | Conventional purchase or refinance loan used to finance improvements and repairs Funds placed in a custodial account and released in payments directly to your contractor | Extensive remodels when you want to borrow money based on your home’s post-renovation value for LTV purposes | 95%, or 97% with homebuyer education | These loans require extra paperwork and compliance requirements when compared to traditional mortgages. The lender releases funds as work progresses, subject to inspections. These loans use your home as collateral, usually at a lower interest rate than unsecured loan options. Funds used to remodel your home may be tax-deductible. |
| Limited FHA 203(k) | Federally-insured mortgage loan to renovate your home | Projects under $35,000 Borrowers who don’t qualify for a traditional mortgage due to a low credit score or have limited equity in their home | 97.75% of the post-renovation value when refinancing an existing loan | These loans have higher fees when compared to a conventional mortgage, with the added expense of mortgage insurance (MI). Government compliance and inspection requirements apply. Minimum credit score of 500 required (some lenders may require higher). |
| FHA 203(k) | Federally-insured mortgage loan for the purpose of renovating your home | Projects over $35,000 and extensive remodels Borrowers who need work done on their home but have a low credit score or limited equity | 97.75% of the post-renovation value when refinancing an existing loan Subject to Location-based loan limits | HUD consultant to oversee closing required. These loans have higher fees when compared to a conventional mortgage, with the added expense of mortgage insurance (MI). Government compliance and inspection requirements apply. Minimum credit score of 500 required (some lenders may require higher). |
| Home improvement loan / Personal loan | Unsecured, fixed-rate loan with a shorter term than a mortgage | Most renovation projects under $100,000 Borrowers with good credit who don’t want to risk using their home as collateral | Not applicable | Home improvement loans may require proof of home improvements or repairs, depending on the lender. These loans usually have a higher interest rate than a conventional loan, home equity loan, or HELOC. |
| Credit cards | Unsecured, revolving line of credit that can be used at your discretion | Small projects and emergency renovations | Not applicable | Credit cards usually have the highest interest rates. Credit cards could be beneficial if you have a low introductory rate and you pay off the entire balance within the introductory period. |
Before you borrow money, look at the big picture
Just because you can borrow money to renovate your home doesn’t mean you should. For one, borrowed renovation funds will add to your existing debt obligations. Secondly, after tacking on interest fees, your project could end up costing significantly more than you think.
To keep your finances healthy, map out a remodeling plan and evaluate your financial situation before you commit to more debt.
Consider the scope and budget of your renovation project
Your first step to evaluating if you should borrow money to renovate is to estimate a project budget. Tally up the contractor bids and any additional costs to complete your remodel. Then pad your budget. Houzz suggests setting aside 20% of your renovation budget for unwelcome surprises, such as water-damaged subfloors the contractor discovers after peeling off the old linoleum or a jump in lumber prices.
“Expect the project to get more expensive over time … if you’re borrowing money, you may want to add a little buffer between your budget and the amount you borrow,” notes Weiss.
If your remodeling budget has more commas than you expected, consider breaking the project into smaller phases that you can tackle over time. Smaller projects could relieve some of the initial financial stress by spreading out contractor invoices. You may be able to save money and pay for the renovation with cash over time, rather than borrow — this route could save you hundreds to thousands of dollars in interest.
Estimate your project’s return on investment (ROI)
If you choose to borrow for a remodel, you increase your debt. But if the renovation adds value to your home, borrowing could be worth it. Depending on the project, your renovation could yield a strong return on investment when you go to sell your home.
For instance, a 2019 survey by the National Association of Realtors (NAR) estimates that a complete kitchen remodel garners a 59% return on investment. New hardwood flooring has an even stronger ROI, with homeowners netting back 106% of the project cost.
On the flip side, some home renovations do not add value to your home. You could also over-improve your home and recoup less of your investment than you anticipate. To estimate renovation ROIs, speak with a top real estate agent in your area. They can advise on what features add value and marketability in your neighborhood.
“Look at the economics of the renovation,” advises Dunn.
“You can see people take out debt and ‘over-renovate’ and spend more money on it than the value it will add to your home.”
Think about your future plans
If you’re planning to move within a few years, freshening up a dated home or replacing an old, leaky roof makes sense to maximize your resale value. An expensive, large-scale renovation like a home addition, on the other hand, may not be worth the financial stress.
If you’re leaning toward a home equity loan or home equity line of credit (HELOC), keep in mind that you’ll have to pay off the debt when you sell if you haven’t already. Both loan types put a lien on your property, and you won’t be able to give the buyer a clear title to your home unless it’s paid off. Your closing agent can help guide you through the process when it’s time to sell.
Evaluate your financial health
Always review your finances before committing to debt. Falling behind on your bills can make you resent even the most stunning kitchen remodel. Think about these financial factors before you borrow:
- Debt-to-income (DTI) and monthly debt payments: Does the added monthly expense of a renovation loan fit into your budget? Divide your monthly income by your total monthly debt payments. If the number is too high, you may want to reconsider adding to it with remodeling expenses. “The general rule of thumb is to have a debt-to-income ratio of 36% or less,” says Dunn. Keep in mind that most lenders will allow you to borrow up to at least 45% DTI or more, but what you can borrow and what you can afford may be two different things.
- Employment stability: Weiss stresses the importance of having a stable income, particularly if you’re using your home as collateral for a loan. If you lose your job and can’t afford the monthly payments, you risk foreclosure and could lose your home, too.
- Cash reserves: Set up and maintain your emergency fund; you shouldn’t tap into this for remodeling unless it’s a full-fledged emergency. Both Dunn and Weiss recommend that homeowners stash away at least three months of expenses for emergency reserves. “Don’t drain your emergency fund to pay for a renovation, thinking that you’ll build it back up after,” warns Weiss. “A lot can happen between the time a renovation starts and stops, and not having an emergency fund in place can be catastrophic.”
Loan criteria to consider when comparing your options
Narrow down your list of loan choices by weighing these factors first:
Loan-to-value (LTV)
The higher your LTV, the riskier the loan from a lender’s point of view, which translates into a higher interest rate.
Some options, such as a HELOC and a home equity loan, allow you to borrow up to 100% of your home value. Borrowing a significant portion of your equity for a high ROI remodel could make sense in a swiftly rising real estate market with low-interest rates. Just remember that your home is collateral if you default on payments.
Interest rate and total interest amount paid over the life of the loan
Look for a financing option with low fees and the best interest rate to lower the overall cost of the financed project. For example, Weiss used a HELOC to draw remodeling funds only as needed, rather than taking out a large lump sum with a cash-out refinance. “This allowed us to minimize the time when interest was compounding,” Weiss comments.
Dunn notes that high-rate credit cards and personal loans usually aren’t the best move, particularly if you don’t pay off the balance quickly. “You may end up paying way more than you think for the renovation if you have to use credit card debt or personal loans once the interest is accounted for,” she says.
On the flip side, you could score a deal if you open a credit card with an attractive sign-up bonus (and commit to making responsible payments). One of Dunn’s clients completed a small renovation project using her credit cards with a strategy in mind. Instead of drawing on her savings reserve, she leveraged a 0% introductory rate to fund her remodel. She paid off the balance before the end of the introductory period, avoiding the high-interest charges.
Cost to acquire the loan
Remember to weigh in closing costs and fees when forming your renovation budget. Conventional refinances could set you back 2% to 5% of the loan amount. But there may be lenders with options and programs that are low or no-closing cost programs. Some banks even offer HELOC programs with no closing costs.
Credit score requirements
Your FICO credit score impacts your ability to secure the lowest interest rate: the higher your score, the lower your rate. But a credit rating that doesn’t meet the lender minimum will knock you out of the running completely.
Time to pay off
The loan term, whether it’s a 30-year mortgage or 2-year personal loan, affects your interest rate, monthly payments, and total interest over the life of the loan. The longer the loan term, the lower your monthly payments tend to be. And the faster you pay off your loan, the less interest you’ll pay.
Should you borrow money to remodel? That depends on your situation
Taking on new debt, particularly for a substantial investment like a home remodel, demands careful consideration. Look at the big picture, price out your project, and lay out a strategic plan to renovate your home while keeping your finances stable. When properly planned, you can have your cake and eat it in your newly remodeled kitchen, too.
Header Image Source: (Jason Briscoe / Unsplash)
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