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Debt Management

Should you use a credit card or home equity to renovate your home?

The best choice depends on the extent of the work and your financial situation

Summary

If you were reluctant to open your home to a construction crew during the colder months, you may be anxious to start on those upgrades now. But if you’re short on cash, you might find yourself deciding between using a credit card or a home equity loan or line of credit (HELOC) to pay for renovation expenses. Here’s how they compare.

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Spring has arrived, and so begins the season for home renovation.

If you were reluctant to open your home to a construction crew during the colder months, you may be anxious to start on those upgrades now. But you need to decide how to finance those projects.

“The first place to start with is savings,” said Jennifer Windsor, certified financial planner and senior financial advisor at Triad Financial Advisors in Greensboro, N.C. Ideally, you’ll have money set aside for renovations so you don’t need to take on debt.

However, if you’re short on cash, you might find yourself deciding between using a credit card or a home equity loan or line of credit (HELOC) to pay for renovation expenses. According to data from Houzz and Synchrony Bank, a growing number of homeowners are choosing the former.

Stats show that homeowners charged around $141 billion for home improvement purchases last year—up from just $84 billion eight years ago. Using credit cards for home projects is particularly popular with younger homeowners, with 41 percent of Millennials saying they’ve used cards to fund at least some of their home improvements.

Are you considering the same move? If so — or you’re just on the fence about how to cover those renovation costs — then read on.

See related:  Home improvement financing: Compare 8 options

Credit cards vs. home equity

Whether you use a credit card or home equity product depends on the extent of your renovations and your financial circumstances. Malik Lee, a certified financial planner and managing principal at Felton & Peel Wealth Management in Atlanta, said credit cards can be useful for smaller renovation projects, up to $10,000, that you expect to repay within a year based on your cash reserves and income level.

Once you get into the higher range of renovation expenses, however, home equity may make more sense from a tax perspective.

Married couples may deduct interest on up to $750,000 in mortgage and home equity debt secured by a primary or secondary residence, while those filing separately or as individuals may deduct interest on up to $375,000 in qualifying debt. Keep in mind that the deduction only applies if the renovations are substantial — such as putting on an addition or repairing the roof.

Cosmetic upgrades won’t qualify for the deduction, so you may want to use a credit card in those cases rather than drawing on home equity you may need when more urgent renovations arise.

Another factor to consider is interest rates. Until recently, interest rates in the U.S. were climbing, though the Fed has signaled it may not raise rates again this year. But you may not secure as favorable a rate on a home equity loan or HELOC as you would have, say, a year ago.

Still, because it’s secured debt, you’re still likely to get a lower rate than you will with a credit card. Average APRs on credit cards are close to 18 percent, according to the CreditCards.com Weekly Credit Card Rate Report. Home equity rates range from 5.92 percent to 6.78 percent, according to Bankrate.

Lee noted that homeowners who are considering a cash-out refinance to pay for renovations should be cautious that they don’t refinance themselves out of a low rate they may have secured in recent years. Even though the increase in rates has slowed, they may not drop significantly again for several decades.

Steve Conard, a certified financial planner at Compass Financial Services in West Des Moines, Iowa, said even in a rising interest rate environment and with the restrictions on what types of interest may be deducted on your taxes, you are likely to secure a lower rate by using your home equity.

The home equity deduction doesn’t apply to every situation, however, and credit cards may be an attractive alternative based on your circumstances.

“If the deductibility of home equity line interest is not a benefit to you because you’ve reached the maximum mortgage limit, or if using the standard deduction is more beneficial for you than itemizing deductions, then you can look to a credit card that comes with some rewards or very low or zero percent interest,” Windsor said.

See related:  Credit card rewards can help sell your home this spring

Pros and cons of using a credit card for home improvements

As with anything, there are definite advantages and drawbacks to using a credit card for your home improvement projects. These vary depending on the type of card you’re considering using, as well as your credit and how quickly you plan to pay off your debts.

If you can pay off the debt quickly, then using a card with a promotional interest rate (or limited-time zero interest rate) can be hugely beneficial in the long run. Using cards that earn you rewards, discounts or cash back can also help you financially.

The main drawback is that, unlike home equity loans, a credit card won’t qualify you for any sort of tax deduction. They could also lead to frivolous spending if you don’t have a tight rein on your budget.

Pros:

  • Could qualify you for cash back, rewards or discounts
  • Lower credit score requirements
  • Doesn’t use your home as collateral
  • Promotional rates could mean paying no interest at all

Cons:

  • Not ideal if you need a long pay-off period
  • Interest rates may be higher than equity loans
  • No tax deduction for interest paid
  • Could make it hard to pay contractors (unless they accept credit cards)
  • May lead to more frivolous spending

What to look for when choosing a home renovation credit card

Here’s what to consider when evaluating credit card options for renovations:

Interest rate: Compare the interest rate on your credit card with the interest you’d pay on a home equity loan or HELOC to determine which works out to a better deal. You’re almost certainly going to receive a lower rate on a home equity product, but consider the repayment timeline as well.

Neale Godfrey, chairman of the Children’s Financial Network, noted that if you take out a home equity loan with a 30-year repayment agreement, you could end up paying three times the principal after factoring in the interest. While a credit card may have a higher interest rate, you may ultimately save money if you’re able to pay it off within a year or so.

Promotional interest rate offers: A card that includes a zero-interest period could help you maintain cash flow during your renovation. This could be a balance transfer card or one that offers a 0-percent APR on purchases for a limited time. However, calculate how much you’ll need to pay each month to wipe out your balance once the promotional period ends and avoid accruing interest.

Home improvement stores may offer their own cards or low-to-zero interest financing or purchase discounts as well. But these cards tend to offer deferred interest deals, which charge interest on the entire purchase amount if you don’t pay your balance in full before the promotional period expires.

Transaction and annual fees: Most balance transfer cards charge a transaction fee – usually 3-5 percent of the transferred balance. You’ll also want to find out whether there is an annual fee so you can factor these expenses into the overall cost of using the card.

Rewards: If you prefer a credit card because you want to accrue rewards, make sure the card offers the bonuses most relevant to your priorities, whether those are airline miles, hotel points or cash-back bonuses. Some cards now offer extra incentives specifically on home renovation purchases.

Consider, too, the monetary value of those rewards.

“You have to decide if the value of those perks are really as valuable in comparison to the interest you would save [by using your home equity],” Conard said. “You have to do the math on that and understand really thoroughly what the value of your rewards are.”

See related:  Best credit cards to finance home improvement projects

Think long-term

Create a budget that accounts for all of the expenses that will be associated with the renovation, including how much your monthly debt payments will be. Godfrey said people often overlook the secondary expenses associated with big renovations as well.

If you put in a pool, for instance, you’ll have to pay the upfront costs as well as for ongoing maintenance. She recommended looking at the full range of expenses you’ll incur, particularly on a non-essential upgrade, and then considering how else you might spend the money. That can put the amount spent on cosmetic renovations in particular in perspective.

Lee said it’s important to distinguish between necessary and fun renovations as well.

“Is this home renovation something fun that will add to the marketability of the home but not so much the value of the home?” he said. If it’s the latter, bear in mind that you’re unlikely to earn back your money when you decide to sell.

Want to make sure you get that money back? Then choosing your renovations carefully is key. According to Bankrate, the highest ROIs come from:

Charge wisely

If you choose to use a credit card for home improvement, Conard urged discipline in how you use it.

“Only use that account for the renovations. Do not intermingle any other types of borrowing activity onto that account,” he said. “Even though it’s not a tax issue, you want to make sure that you’re able to pay it off during that zero-interest period, or get it pretty darn close.”

Using the card for purposes other than renovation can lead to a higher debt load that becomes untenable once your promotional rate ends.

By thinking strategically about whether to use a credit card or home equity product, you can improve your home and come out ahead financially.

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