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Home improvement financing: Compare 8 choices

By Dana Dratch

If you're making home improvements, will that be cash, credit card or loan?

8 HOME IMPROVEMENT FINANCING OPTIONS
Compare home improvement, repair finance choices
Improving your home? Nail down how you'll pay for it first. You'll likely pay in one of eight ways:

 

COMPARE: Pluses, minuses of each choice, what they're best suited for

According to Harvard University's Joint Center for Housing Studies' 2015 report, home rebuilding is on the rebound. American homeowners in 2013 spent nearly $300 billion, and 2015 spending was expected to be even higher. In a survey released in April 2016, 28 percent of American homeowners have plans to remodel in the next 12 months, with exterior renovations the most popular project.

Just as contractors match the right tool to the job, savvy homeowners match the size and scope of the project to the right sources of financing.

Today's homeowners are using some of the old favorites, including cash and credit cards. Other methods of financing have taken a hit in recent years. For example, home equity-based loans have been harder to come by since house prices plunged after the housing crash. And some homeowners are tapping into a few lesser-known options, such as FHA remodeling loans and contractor-sponsored financing.

"In general I would say a rule of thumb is to think about how much you're actually borrowing and how long before you could reasonably pay it back in full," says Linda Sherry, a spokeswoman for advocacy organization Consumer Action. At that point you can determine the method of payment that will match your financial situation.

Here's a rundown of the most-popular remodeling financing options:

No. 1: Cash
When it comes to home renovation, cash is king. It's the low-stress option, with no pesky fees, contracts, interest rates or looming debt. According to a 2013 survey by home improvement site HomeAdvisor, two out of three respondents said they had paid for home improvements with cash rather than finance.

But what if you don't have enough cash to get the job done? If you use loans, credit cards or anything other than cash, the big question to ask is, "Do you need this additional debt?" says Doug Borkowski, assistant director and lecturer of Iowa State University's Financial Counseling Clinic.

No. 2: Credit cards
If you're going to use credit cards, make sure you can pay the loan back in a reasonable amount of time, such as six months or a year, says Sherry. Some card issuers have products geared to those who want to make renovations. For example, Pentagon Federal Credit Union is marketing its PenFed Promise Visa Card toward home renovators, touting the card's lack of fees and its low, three-year 7.49 percent introductory interest rate.

Disciplined homeowners could also use a credit card with a zero percent introductory rate to pay for renovations and spend no money on interest, "but the trick is to pay off the full loan within the introductory period," says Sherry. Also be wary of offers in which interest is applied retroactively if you don't pay the entire balance during the introductory period.

Once you get beyond the introductory rate, APRs on low interest credit cards are running in some cases at about three or four times the rate of home loans and refis. The current average rate on credit card offers is running at about 15 percent.

No. 3: Personal loans
Depending on your relationship with your bank or credit union, you may also be able to get a small, unsecured loan. Often called personal loans or signature loans, they could be a good deal depending upon the loan terms and the interest rate, which can be lower than that of a credit card.

According to the Federal Reserve, in February 2013 the average interest rate on a 24-month personal loan was 10.12 percent, compared to an average of 11.93 percent for credit card accounts.

No. 4: Home equity loans
During the housing market crash, standards tightened for any loan that involved home equity. Lenders wanted to see excellent credit scores, and the maximum amount many would loan (including other mortgages) was 90 percent of the home's value. Today most lenders limit what you can borrow even further, to 85 percent of the home's value, says Frank Donnelly, chairman of the Mortgage Bankers Association of Metropolitan Washington, D.C. Many lenders also look for credit scores of at least 700 to 720, Donnelly adds.

Those high standards for home equity loans may be loosening: A 2012 Survey of Credit Underwriting Practices by the U.S. Treasury Department found that 18 percent of banks had recently eased their underwriting standards for home equity loans.

Home equity loans typically offer fixed rates for fixed terms that run from 10 to 15 years.

The rates for home equity loans are typically higher than those for traditional mortgage loans or refinances. For example, the average rate for a $30,000 home equity loan in April was 6.23 percent compared to 3.57 percent for a 30-year fixed mortgage.

No. 5: HELOC
A home equity line of credit (HELOC) also siphons home equity, but instead of getting a lump sum, you're approved for a set amount and take it as you need it. "With a typical home equity line of credit, the nice thing is when you pay it down you can draw on it again; you don't have to run to the bank every time you want a loan," says Donnelly. As with home equity loans, your ability to get a HELOC will depend on whether you have enough equity in your home. But unlike home equity loans, which are largely fixed rate products, HELOCS typically offer an adjustable rate.

Some lenders have specific rules regarding home equity products. For example, some lenders will not lend an equity line on a condo, Donnelly adds. Interest rates on HELOCs are slightly lower than home equity loans, but since the rate is not fixed, they may rise as interest rates rise.

On a side note, the interest you pay on a home equity loan or a HELOC is usually tax deductible, up to $100,000.

No. 6: Cash-out refinancing
One option homeowners sometimes use is a cash-out refinancing, in which people take some equity for improvements while also giving themselves a home loan do-over. Of course in order to do that, you must have equity in your home to pull from, a fact that disqualified many people during the housing market crash. However, a 2013 study by American Express found that of those who recently refinanced or plan to within months, 12 percent planned to spend the extra money from the refinance on home improvements.

With interest rates low, now might be a good time for refinancing anyway, so if you have equity in your home, getting a cash-out refinancing could make sense.

When determining whether refinancing is for you, what you want to see is one percentage point or better than what you already have, financial experts say. Figure in all your fees and expenses and determine whether the payoff of home renovations is worth the investment in equity. You do the math on a refinance calculator.

No. 7: FHA Title I remodeling loan
A lender you may not have considered: the government.

The Federal Housing Administration's (FHA) Title I Home Improvement Loan Program is fairly small – 5,576 loans in 2015 – but it can be a good deal for consumers. It doesn't require a specific amount of (or any) equity in the home. Owners can borrow up to $25,000 for up to 20 years for single-family homes. Loans of more than $7,500 are secured with the home itself.

The lending banks and credit unions set the lending standards and may require a certain amount of equity. They can also charge fees, but the federal government "limits the amount for some of those fees," says Lemar C. Wooley, spokesman for the U.S. Department of Housing and Urban Development. Projects are limited to a set (but broad) list of improvements. HUD's website includes a lookup tool for FHA lenders. Interest rates vary, according to HUD, but are typically lower than current market rates.

No. 8: Contractor financing
In addition, some contractors are offering financing services, says Bill Simone, president of the Los Angeles-based Custom Design & Construction and a member of the steering committee for Harvard's Joint Center for Housing Studies.

With contractor loans, terms will vary widely. What you want: a fixed rate, no points and no junk fees, says Simone. Rates "depend on a client's credit," he says. For example, his company's loan rates range from 4 percent to 9 percent.

When your lender is your contractor, it's doubly important to vet him in both roles. Check with past clients, the state consumer affairs office and do an online search that includes the Better Business Bureau, your state and local government's licensing offices and the local newspaper.

 

COMPARE HOME IMPROVEMENT FINANCING CHOICES
CASH
Pluses Minuses Best for
No debt, interest rates, credit check, paperwork, payments, loan fees or closing costs. And you know exactly what you have to spend. Do you have a better use for this money? Whatever amount you can comfortably cover at one time. For many, this would be smaller projects.
CREDIT CARDS
Pluses Minuses Best for
No closing costs, home appraisal or loan fees; no credit check, and you're not using the house as collateral. Depending on the card, you can earn discounts on materials and supplies, airline miles, points or cash back. Your right to "charge back" could give you some recourse if contractor disappoints.

Increasing your debt load. APRs are two, three or four times as high as interest rates on home equity loans and mortgages; interest is not tax deductible. Running up the card could lower your credit score, and one risk is a card issuer could cut your spending limit.

An amount you can comfortably pay off fairly quickly. For most, this would be smaller projects, or an ongoing remodel where you expect to be making substantial payments regularly.
HOME EQUITY LOAN
Pluses Minuses Best for
With a fixed-rate loan, no surprises. Rates better than credit cards and personal loans. Interest is usually tax deductible. Requires home appraisal, equity and good credit. Increases your debt load – with your house as collateral. Costs and time associated with loan similar to those of a first mortgage. Projects with a price tag large enough to justify the costs and paperwork.
HOME EQUITY LINE OF CREDIT
Pluses Minuses Best for
Take as much as you need, when you need. Usually has a variable rate, but some may have fixed-rate options. Interest should be tax deductible. Lenders often waive many or all fees. Requires home appraisal, equity and good credit. Increases debt load, with house as collateral. Borrowers sometimes confuse introductory rate with permanent rate. Substantial projects that may extend over a longer period of time. Projects where you may need some monetary flexibility.
CASH-OUT REFINANCING
Pluses Minuses Best for
The opportunity for a "do-over" on your mortgage rate. Next to cash, a fixed-rate loan is potentially the cheapest money available for home renovations. Interest should be tax deductible. The math doesn't work for every homeowner – not worth it if you can't beat your current rate. Some cash-out loans will come with a higher interest rate. Requires home appraisal, equity and good credit. Increases your debt load – with your house as collateral. Costs and time associated with loan similar to those of first mortgage. Homeowners who want to refinance; projects with a price tag large enough to justify the time and cost.
FHA TITLE I PROPERTY IMPROVEMENT LOAN
Pluses Minuses Best for
May not be any equity requirements or origination fees. Loan term can be up to 20 years. Many participating banks and credit unions. Not as prevalent as some financing. The agency says 5,576 such loans were made in 2015. Lenders may set their own lending requirements regarding equity and home value. Homeowners with little or no equity who need to borrow less than $25,000.
PERSONAL LOAN
Pluses Minuses Best for
Not putting your house at risk. Not all banks and credit unions make these loans; rates likely twice as high as for conventional home equity or mortgage loans. Requires good credit. Adds to your debt load. Smaller improvements for homeowners with good credit.
CONTRACTOR FINANCING
Pluses Minuses Best for
Convenient – same office that handles the remodeling work also handles the loan. Not all contractors offer it. Have to vet your contractor as a building pro and a lender. Requires same process as mortgage loans. Need to shop rates to see if you're getting the best deal. Adds to your debt load with your house as collateral. Need an escape plan: What happens if you want to fire your contractor? Jobs of varying sizes, as well as homeowners who want convenience.

Updated: April 15, 2016


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Updated: 12-08-2016


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