Financing

Finding the best financing for a project is as important as identifying the right contractor or products, when you consider the long-term effect on your wallet. A difference of 1 percentage point in the interest rate on $25,000 that you borrow on a home-equity line of credit, for instance, will increase your minimum payments $250 per year.

How to Choose

Select your financing based on the kind and size of project you’re planning and how much equity and cash you can spare. Then compare like products’ interest rates, expressed as an annual percentage rate (APR). Costs such as origination fees and early-termination fees are worth comparing, though they become less important the larger your total project. Here’s a rundown of your major options:

Savings. Use cash from savings or liquidated investments if you have the money available and don’t want to worry about future debt. The majority of our clients use this route. In a recent survey, 61 percent of people who spent $20,000 or more on a kitchen remodel financed most of the job with cash. Before you start writing checks, however, it’s wise to consider the opportunity cost: How much might that cash have earned if it had been invested? Currently, an insured, 4 percent money-market account wouldn’t make more than the 7 or 8 percent you’d pay when borrowing from your home equity. That makes paying in cash a better deal than incurring debt.

Home-equity line of credit (HELOC). This type of financing is best if you think you’ll have several projects or needs over several years. You’re offered a credit line and an interest rate based on the value of your home, your liabilities, and your credit score. As with a credit card, you borrow only what you need, making interest and principal payments when you start a balance. You’re generally allowed to spend from the account for 10 years. The floating interest rate is based on the prime rate plus or minus some percentage points. Interest payments on debt amounts up to $100,000 are tax-deductible.

HELOCs generally have few if any fees because the market is so competitive. According to HSH Associates, a publisher of financial information, the average closing fee charged for HELOCs is about $60. Some lenders make you pay a maintenance fee, typically about $50 per year, if you don’t keep an outstanding balance. But Keith Gumbinger, HSH vice president, says that fee may be worth it to ensure that you have access to cash for emergencies. “They can make a nice, cheap insurance policy to tide you over a rough spot,” he says.

Home-equity loan. This is best for a one-time purpose, and for people who can’t stomach interest-rate changes inherent in HELOCs. This type of financing has gained ground against HELOCs, which are based on the fast-rising prime rate. Like the HELOC, this loan is secured by your home’s equity. The rate, and the borrowed amount, is fixed. You may be asked to pay closing costs such as recording fees, appraisals, origination fees, and discount points, which can add as much as $1,000.

Cash-out refinance. This is an option for big projects done when housing prices are rising and interest rates are going the other way. You take out a whole new first mortgage that’s bigger than the original, using the equity buildup in your home for the renovation.

Credit card. This is a reasonable choice when your project will cost just hundreds or thousands of dollars and you expect to pay back the money in a few months. With fixed rate interest rates on platinum cards averaging about 10 percent and on standard cards averaging 13 percent, this is costly for the long-term.

401(k) loan. Your employer might let you borrow from your 401(k). The interest you pay goes back to you, not to a third party. But you’ll be stunting your retirement savings, and you will have to pay off any balance if you leave the job.