You want to renovate your home, but find yourself without the cash to do so right now. While you might be able to obtain a personal, unsecured loan, the interest rates on it might be higher than what you want to pay. Another option is a home renovation loan. You have several options when you already own the home. Lenders may offer you a home equity line of credit, a home equity loan, or a cash-out refinance.
No matter which loan you choose, you’ll pay interest. How much interest you pay does depend on the loan, though.
Home Equity Line of Credit
The HELOC, or home equity line of credit, usually has the lowest interest rate. Don’t fall for this loan just yet, though. Yes, you do get a low introductory rate, but the rate is variable. In other words, it could change from month to month. There’s no way to predict your rate either.
The good thing about the HELOC is you only pay interest on the funds you use. Let’s say you take out a $50,000 HELOC, but you only draw $10,000 of the funds right away. You would then only pay interest on that $10,000. If you leave the remaining $40,000 untouched for the remainder of the term, you’ll never pay interest on those funds.
Home Equity Loan
The home equity loan works a little differently. With this loan, you don’t get to draw funds as you need them. Instead, you receive the funds as one lump sum. You can put the funds in a savings account or some other safe place to use them as you need.
Because you draw all of the funds at once, though, you start paying interest immediately on the full amount. The interest rate charged on this loan is usually slightly higher than the HELOC too. But, your chances of securing a fixed-rate are much higher on this loan. So you may pay a little more interest upfront, but you never have to worry about the rate changing.
Your final option is the cash-out refinance. With this loan, you refinance your first mortgage and take out a larger amount. Let’s say you owe $150,000 on your current mortgage, but your house is worth $300,000. You may be able to take out up to 80% of the home’s value with the cash-out refinance. In this case, that means an additional $90,000 for your home renovations.
Lenders take a risk when they give you a larger loan than your outstanding first mortgage. Because of this, the interest rate on the cash-out refinance is usually the highest amongst the three choices. This doesn’t make it the worst choice, but it does mean it will cost you more to keep this loan, especially if you take a 30-year term. The longer you borrow the money, the more interest you will pay on it over the life of the loan.
So do home renovation loans carry higher interest rates? It depends on the chosen loan as well as your qualifying factors. Just like any other loan, lenders base your interest rate on the risk you pose. If you have borderline credit scores and high debt ratios, you may end up paying higher interest rates. If, on the other hand, you have great credit and low debt ratios, lenders may give you access to lower interest rates even on a home renovation loan.