Home Renovation Financing: What Homeowners Need to Know Before Starting
Learn the smartest ways to finance home renovations, compare home equity vs personal loans, avoid common mistakes, and protect your cash flow.
image for illustrative purpose
It's hardly ever the case with a home renovation project that the final bill is equal to the first estimate. You find yourself going over budget for materials, contractors unearthing hidden problems, and a change in project scope turning a small update into a complete overhaul. The wise homeowners resolve the issue of financing beforehand with no wall demolition yet rather than gather up money from here and there at the time when they are out of cash.
The way you finance your project determines the impact on your cash flow right now as well as your financial health in the long run. Doing this properly at the very beginning saves you from making expensive mistakes.
Understanding Your Options
Most homeowners weigh the option of borrowing against their house value through home equity products or signing up for unsecured personal loans. Both have their pros and cons depending on the circumstances.
A home equity line of credit or home equity loan is secured by the property that you use as collateral. Interest rates are generally lower as the loan is secured by your house. The risk is clear: failing to make your payments can lead to the loss of your home. Besides the risk, the application process also takes time, usually a couple of weeks, and involves the need for an appraisal.
On the other hand, personal loans are great for convenience and are straightforward. As you won't need your home to be appraised, or for equity, and once the loan is approved the money can be disbursed in a couple of days. Since the loans are unsecured, the rate will be higher than for secured loans but you won't risk your home even if your repayment fails.
For smaller projects under $50,000, many homeowners find that personal loans for home renovation provide the right balance of accessibility and reasonable terms. The faster funding timeline also helps when contractors need deposits to begin work.
Matching Financing to Project Scope
The amount and scope of your remodeling must be the main factor in your financing decisions. A $15,000 kitchen makeover is not the case of a home equity application. A full-fledged home addition that costs $100,000 definitely is.
Also, think about the schedule. Renovations that are going to last for many months could be the usage of a line of credit against which you can withdraw money as needed. Short, fixed-cost projects are more in line with loans where you get all the money upfront.
It is necessary to take into account the expectations of the contractors' payments as well. Some of them will ask you for considerable deposits even before they order the materials. On the other hand, there are those who operate on milestone-based payment schedules. It is by understanding these requirements that you facilitate choosing the financing that suits the real flow of the spending.
Avoiding Common Mistakes
Underestimating project costs is the main cause of financing problems. According to industry wisdom, you should always add 20% to any contractor's estimate as a contingency buffer. If the financing is done only for the estimated amount without contingency, the homeowners will have to look for more funds during the project and this may be on worse terms.
Another mistake is not thinking about total cost but only focusing on monthly payment. The longer the loan term, the lower the monthly payment will be, but the total amount of interest paid will go up significantly. For instance, a renovation loan spread over ten years will end up costing much more than if the same amount is paid back in five years, even if the monthly payments seem more comfortable.
Not checking credit before the application is a waste of your time and can also negatively affect your credit score. Typically, every application brings about a hard inquiry. If you check your credit yourself first and clear up any mistakes, you will not only have higher chances of getting approved but you will also get better rates.
The Smart Approach
Make sure you get complete bids from contractors before you look for financing. It's better to fund what you know exactly rather than guess. When comparing different financing options, use APR instead of the rates shown in the advertisement. Consider all fees, not only interest.
Lastly, make sure the renovation indeed adds value. There are always projects that do not recover their costs at sale. If you finance the improvements that don't add to your home's value, you will have to pay interest on the upgrades that are losing value. Concentrate on the renovations that will work on both your living condition and your equity.
