You’ll have a lot of decisions to make during your home renovation—how to pay for it is probably the biggest. That’s because making an investment in a home you love right now shouldn’t end up costing you for years to come. But too often homeowners make really bad choices when it comes to financing their project, and that’s exactly what happens.
Here are 6 of the dumbest things homeowners do when paying for a renovation:
1. Drain Their Emergency Savings
It’s hard to enjoy that brand new master bedroom or kitchen when you can’t stop stressing about the huge hole it left in your bank account. Your thoughtfully planned renovation project is definitely not an emergency, so you shouldn’t use those savings to pay for it. Plus, if any unforeseen issues arise during construction, and you have nothing to fall back on… just don’t put yourself in that position.
2. Use a High-Interest Rate, Unsecured Personal Loan or Credit Card
A great choice for your bank, but not for you. If high-interest and unsecured aren’t red flags enough, let us explain. The higher interest rates—we’re talking best case 10% (according to LendingTree)—and shorter terms of a personal loan mean unnecessarily high monthly payments. Or if you use a credit card and choose to pay back the minimum each month to avoid interest rates around 18.2% on average (reported by WalletHub), you’ll never be debt-free. The result of both of these options is the death of your cash flow—without even a tax benefit. We’ll pass.
One of the reasons why homeowners are so drawn to these options is because they are often marketed as “home improvement” loans. Contrary to to what you may have read online, these types of loans are not specialist financial products designed for home improvement projects. These are simply unsecured, personal loans marketed toward people looking to renovate their home.
While “home improvement loans” may advertise up to $100k in borrowing power, oftentimes only people with the very best credit scores (800) can access this amount, and those whose credit isn’t perfect cannot borrow NEARLY as much.
Just because a loan is marketed toward renovations, home improvement projects, or remodeling, doesn’t mean you should use it for your own home. Make sure to read the fine print, because you’ll probably be getting sucked into a higher interest rate, higher fees, and much less borrowing power to boot.
3. Borrow From Their 401k
While this isn’t the worst option on the list, why would you ever want to take from your own retirement? What’s worse is that repayment will actually cost you more than your original contributions since you’re paying back borrowed pre-tax funds with after-tax money. And due to the surprisingly large principal of these loans, it’s unlikely to pay it back quickly, no matter how optimistic you are. Let’s face it, no one actually likes borrowing money, but if you have to, borrowing from your retirement fund may not be the best choice.
4. Refinance Their House into a Higher Rate
There’s that higher rate again. When you choose to take cash out of your homes, it’ll probably end up costing you. Just about 60% of cash-out refinances in 2018 came with higher interest rates—the biggest share since before the financial crisis—according to Black Knight Inc. Just think about it. When you’ve already spent however many years paying into a loan, why would you want to end up back at square one?
5. Use a Construction Loan Unnecessarily
Most homeowners shouldn’t use a construction loan to finance their renovation.
Even your contractor hates them—they might even flat out refuse to use one. These loans require a lot of extra paperwork and multiple inspections, and the bank withholds a nice chunk of your money throughout the project. None of this is ideal for either of you. But what’s worse is that they also require you to refinance your first mortgage (refer to disadvantages in #4) and hit you with tons of additional fees. Many of these loans will also take you from a fixed rate to an adjustable-rate mortgage during the process, which means your rates can rise even more over time.
Instead, renovation home equity loans, like a RenoFi Loan, have no inspections, no major delays, no required refinancing. You’re in control of the distribution of the funds, so there are fewer unwanted surprises and costs along the way.
6. Borrow Money From Their Family
A good rule of thumb: don’t borrow money from anyone you need to see at Thanksgiving. Family and finances are usually never a good mix, so if you like your relatives, don’t risk it.
Smarter Ways to Pay for Your Renovation
So what is the smart way to pay for your renovation? Well, if the option allows, cash is always king. But for most homeowners—like younger families or those who just used a lot of their cash on a down payment, financing can be a great option if you do it the right way.
The average American household had a bank account balance of $41,700 in 2019. It’s very likely that this won’t be enough to fund a major home renovation. And why would you want to drain your entire bank account when there are other options?
If you have the equity, you’re looking at two solid options: <a href="/guides/home-equity-loans-for-renovations/“Home Equity Loans and HELOCs or a Cash-out Refi — both of which offer higher borrowing power at the lowest low rates.
However, most new homeowners don’t have enough equity to tap into these financing options. Take a look at this chart that shows an example of how equity builds for a family over 10 years after purchasing a home.
A RenoFi Loan
Or if you’re light on equity, a RenoFi Loan is the perfect solution. RenoFi Home Renovation Loans factor in what your home will be worth after the renovation. This allows you to borrow more so you can tackle your entire renovation wishlist.
On average, homeowners can borrow 11x more with a RenoFi Loan, compared to a traditional home equity loan.
Check out this comparison table to see how your renovation loan options stack up:
|RenoFi Loans||Standard Home Equity Loan||Construction Loan||Personal Loan||Cash||Cash-out Refinance||Fannie Mae Homestyle or 203k|
|Loan based on the after renovation value||Yes||No||Yes||No||No||No||Yes|
|Borrow up to 90% post reno CLTV||Yes||No||No||No||No||No||Yes|
|Requires inspections & draws||No||Yes||No||No||No||Yes|
A RenoFi Loan is a great alternative for homeowners who are considering a home equity loan or cash-out refinance to pay for an in-ground pool, outdoor kitchen, or patio area but don’t have enough equity to borrow as much as they’d like.
By borrowing based on your home’s after renovation value, you can increase your borrowing power by more than 11x.
The main things you need to know about RenoFi Loans are:
- Loan amounts from $25k to $500k
- Terms up to 20 years
- Ability to borrow up to 90% of the after renovation value
- Full loan amount available at closing
See how much you could borrow with a RenoFi Loan using the RenoFi Loan Calculator .