What’s Your Budget?
A home improvement project can be tricky as far as figuring out the best way to pay. But a starting point is the cost of the project. You must first determine how much you can easily afford to pay out of pocket with cash, or monthly with financing. Some questions that you can ask as you start to think about this are:
- Do I have cash available for this project and if so, how much?
- If I would rather preserve my cash, what’s the monthly amount that I can afford to repay under a loan?
- If I take out a loan, will I want to pay it off quickly, or will I want to keep the loan for a long term?
Once you have answered these questions and have arrived at a budget, the next thing to keep in mind is that most renovations go over budget. They get caught up in the excitement of the project and then unknowns rear their ugly head, increasing the cost of the project. In order to address this, it’s important to add a contingency, typically around 10 to 20%.
Once you have your budget, let’s take a look at the most common ways that people pay for home improvement projects.
Cash is the first option that most people think about for their home renovation projects. This approach allows you to avoid taking on additional debt, including revolving credit card debt. Another advantage of this approach is that it does not reduce the equity in your home, which would be the case if you were to take out a home equity loan or line of credit (HELOC).
Using cash remains a popular payment option for renovators. According to a 2019 study from Harvard‘s Joint Center for Housing Studies, if a project is less than $10,000, people paid with cash about 78% of the time, utilizing financing 22% of the time.
Yet, according to Angi’s 2020 State of Home Spending Report, the total amount spent on renovations increased year-to-year since 2019. In 2020, the average amount spent on a home improvement project increased to $13,138 from an average of $9,081 the year prior.
And if we go back to the Harvard University study, if a project is over $10,000, the percentage of people who paid with cash decreased to 60%, and as project costs increase further, it becomes evenly split, with people using financing about 50% of the time.
Given this, it is often the case that having available financing options is critical to people realizing their renovation dreams. And for these reasons, it is important to look at other ways to pay for your project.
One of the advantages of a credit card is that you already have a line of credit and do not need to go through a loan approval process. Couple that with its ease of use, and that is why a credit card is the option that many homeowners find themselves using more than they would like. The reasons to think about not using a credit card are that it is a lending product that has revolving debt, compounded interest and 1-3% minimum monthly principal payments. All of these things can make the total interest paid on a card extremely high if you’re not careful. A 2021 study published by the National Bureau of Economic Research finds that between 9% and 20% of credit card customers pay the minimum even if they could afford to pay more. In addition to this group, there are the people that, due to life events, find themselves able to pay only the monthly minimum. Take a look at the comparison below from Upgrade that shows the cost of revolving debt under a credit card compared to an installment loan option provided under a personal loan.
Another drawback of a credit card is that the rates can be high. The average credit card rate is over 16%. In summary, while credit cards clearly have advantages of speed and convenience, they come with quite a few drawbacks that need to be considered before using them.
Some home-renovation contractors offer financing. The advantages of this form of financing is that it comes with the convenience of being presented with a clearer sense of what the project entails, including the price. Some contractors may even offer 0% financing, which can be an attractive offering if you are confident that you can pay off all of the loan within the promotional period. This is typically 6 months, 12 months or 24 months.
The primary disadvantage of contractor financing is that most contractors offer only one loan option. The contractor is not the lender, they partner with a lender and make that lending option available to you. Unless you do your own independent comparison for loan rates and terms, you may not obtain the best rate and terms. Another thing to consider is that oftentimes a contractor wants a down payment before starting the work. Contractor financing, which provides that the contractor will receive the funds once they complete the job, doesn’t give you the liquidity to make this initial down payment. You have to come out of pocket for this. If you decide to take advantage of contractor financing, make sure to consider other options and confirm that your contractor’s rates and terms are competitive.
Unsecured Personal Loan
An unsecured personal loan is a good option if you want to preserve the cash you have, if you want to avoid additional credit card debt, and the cost of the project does not exceed about $75,000. As discussed below, major renovations approaching $100,000 are typically best financed through a mortgage-related loan, like a HELOC.
The advantages of a personal loan are the speed and convenience of applying for and receiving the loan. This is the case if you utilize an online lender. The lending application process typically takes minutes. Completing the loan is a contactless experience with funds available in your bank account within one to three days. Securing a personal loan from a bank or credit union can also be an option if your bank offers one, but it does not come with the speed and convenience, nor the contactless experience.
Before applying for a personal loan for your home improvement project, you should compare home improvement loan lenders. Look for lenders that offer a range of interest rates to suit most credit profiles and multiple repayment term options. One way to achieve this is to use an online personal loan solution that has multiple, national lenders integrated into it. This way, with one common application, these lenders consider your application real-time and present their best offers to you instantly.
Another advantage of a personal loan is that you do not have to have the exact price quote before applying. Unlike a mortgage related loan where you need to be clear on how much equity you’re taking out of your home, or with financing from a contractor where they present financing only after they have worked up a quote, with an unsecured personal loan you can be a little bit more flexible. Try to find a personal loan where you can prepay without penalty. That way, if you borrow a certain amount for the project and it runs under budget, you can use the remaining funds to prepay the loan without penalty. When you secure a personal loan upfront like this, you can proceed with your project with confidence, negotiate prices and complete the project.
Home Equity Loan or Line of Credit. A home equity loan or line of credit is typically the best financing option when you have a major renovation project you want to complete, typically over $75,000. And given the size of the loan you’re taking out, this is usually the best option to ensure that you get the lowest interest rate that you qualify for, and the longest terms to fit the monthly payments in your budget. These rates and terms are available because the lender will take a mortgage interest in your property, allowing you to receive offers with lower interest rates and longer terms than other financing options.
But a HELOC comes with one major caveat: you must have enough available equity in your home. In considering a HELOC, you need to make sure that you have at least 20% equity in your home. In addition, securing a HELOC requires more costs and time than other options. The average time it takes to complete a HELOC is approximately 90 days. For many homeowners that want to complete a project of a moderate to large size and get going quickly, a HELOC is not a good option. The other primary drawback to a HELOC is that you are taking equity out of your home and losing the appreciation value of that amount. This is a major consideration when thinking about taking out a HELOC for your home renovation project.
As a wrap up, you should first decide on your budget. Once you have done that, you should decide amongst cash, credit, contractor financing, a personal loan or a HELOC as the way you pay for the home renovation project. Happy renovating!