Borrowing money for home repairs is more common than you may think. Many homeowners want to take on a home improvement project but put it off for years or decades because they don’t have enough cash. If you’re in this position, there are options.

How Much Should I Borrow for Home Repairs?

To determine how much to borrow, you should first look at the scale of your project to decide if it’s worth it to take out a loan in the first place. Will the renovation make living in your home more enjoyable? Will you recoup the money spent in the eventual sale of the home? If you determine that it is worth it, set a budget and carefully examine your finances to figure out what you can afford to spend and how much you need to borrow. But it’s not just how much you should borrow, it’s also a question of how much a lender is willing to lend you. And there are many factors that go into that decision.

Credit. Your credit score is what determines your creditworthiness based on your credit history, including debt and payment history. People with lower scores will face higher interest rates and smaller loans.

Loan-to-Value Ratio. The LTV ratio tells you how much of your home’s value you are borrowing and gives you a percentage of the value of your home. To get your LTV ratio, divide the mortgage amount by the home’s value. This number tells the lender how much of a risk they’re taking by giving you a loan. The lower your LTV, the better. For many lenders, 80% is the maximum they will lend.

Debt-To-Income Ratio. To decide your loan amount, lenders also look at your income. They want to know what you can afford, but they also want to know your expenses. Your DTI ratio is the percentage of your income that is spent on your debt. It is your total monthly debts divided by your gross monthly income. Like with LTV ratio, the lower the better.

Interest Rates and Loan Term. Interest rates affect how much you can borrow/afford, because the higher the interest rate, the higher the total interest due. And your interest rate is also determined by your finances. Better LTV and DTI ratios will allow you to get lower interest rates, meaning you will pay less interest and be able to afford a bigger loan. With a longer loan, you will pay less on a monthly basis, but your interest will be higher because the interest adds up over the years. Shorter loans bring less total interest, so you can afford a bigger loan.

How Can I Borrow Money for Home Repairs?

Once you determine how much you should borrow, you will also want to choose the right loan for you out of the numerous options available.

Personal Loan

The first thing to know about a personal loan is that it is not secured against your home, meaning your home will not be used as collateral. So you will likely not need to share any information at all about your house (such as value, inspection report, etc…) with lenders. Lenders determine if and how much they should lend you based solely on your financial situation. Because your home is not involved in the loan, you can get a personal loan faster than other loans, but they also tend to have higher interest rates than other kinds of loans, such as a HELOC.

A personal loan is probably best used for an emergency repair, such as if your air conditioner breaks, but it can also be a good option for homeowners who don’t have a lot of equity in their home, who don’t want a secured loan (using their house) or who have a less expensive renovation (under $10,000). It could also be a good option if you’re looking for a shorter-term loan that you can pay off faster. But know that you will likely have to pay closing costs. Rates can be fixed or adjustable, but the better your credit, the better your rate will be.

Credit Cards

Using a credit card may be the easiest and fastest way to fund your home renovation, but it doesn’t mean it’s the best way, as credit card interest rates (also called APRs) tend to be high. It may be a good option for smaller, shorter projects or if you’re in a bind with an emergency repair, but it’s probably not a great idea for the long-term. You could use credit for larger projects as well, but it would depend on your credit limit unless you’re spreading the cost out over more than one credit card. There’s no application process because you already have a credit card unless you apply for a new credit card to share the load. There are cards with a 0% APR promotion, which could be a good option for a short renovation that you can pay off quickly. But if you don’t pay it off before the promotion is up (generally 18 months maximum), you will be subject to high-interest rates.

Cash-out Refinance

This option is a refinance in which you replace your current mortgage with a new, bigger mortgage. This allows you to use your home equity to get money. It’s important to know this is different from taking out a second mortgage because you’re not paying off two mortgages. Instead, you are replacing the old mortgage with a new one. You basically borrow a larger amount than you currently owe and use that money to fund your renovation (or whatever else you choose to spend it on).

This may be a good option if interest rates are low (preferably lower than your current mortgage), but beware of closing costs and compare them to the cost of the renovation. Closing costs are generally in the range of 2-5% of the mortgage, meaning on a $200,000 loan, you could pay $10,000 just in closing costs alone. If your renovation budget is less than or the same as the closing costs, a cash-out refinance might not be worth it. To determine if this is right for you, calculate and compare the total cost of both loans. And just be aware that with a cash-out refinance, your new loan starts over regardless of how much time you have left on your original mortgage.

Government Loans/FHA 203(k) Rehab Loan

The government can also issue loans to help pay for renovations. They differ from state to state, but they generally have standard requirements, such as you can’t sell the home for a certain amount of time (typically 10 years) and it must be the main home you live in. There are loans for renovations to make your home more energy-efficient and for renovations due to a disability. But there are many options to look into.

The FHA 203(k) Rehab Loan is one such government loan. It combines your home improvement loan and your mortgage into one, which can be helpful if you buy a “fixer-upper” that needs a lot of work. Because it is government-backed, this loan is beneficial to those who are low income or have questionable credit (even in the low 600s). It offers a low down-payment of 3.5% and low-interest rates. But this loan does have requirements for spending--the renovation must be over $5,000 and the money cannot be used for unapproved projects.

Home Equity Loan

Also called a HEL or a second mortgage, a home equity loan is a secured loan that allows you to use your home equity to get money. With a home equity loan, the lender gives you a lump sum (even up to 100% of your equity in the home) which you pay off every month until the loan is paid. Because the home is collateral, you will get lower, fixed rates, but you can also face foreclosure and lose your home if you default on the loan. This is a second mortgage, so it does not replace your original mortgage like a cash-out refinance. That means you will make payments on both loans.

To qualify, you will need to have at least 20% equity in your home, as well as a good credit score and stable income. It is also important to note that you are required to pay interest on the full loan amount. This may be a good option if you have a lot of equity and need some extra cash for a one-off renovation. But since you will need to pay closing costs (2-5% of the loan), you should determine the cost of your renovation to see if the loan is a good choice.

Home Equity Line of Credit

A HELOC is similar to a HEL but is more like a credit card. Using your home as collateral, it allows you to withdraw up to a certain credit limit as needed. You pay it back monthly based on your interest rate and the amount you borrow. With a HELOC, instead of paying interest on the full loan amount, you only pay interest on the amount you withdraw. But the interest rate is variable and can change, so you won’t always know what your next payment will be. Just like with home equity loans, you must have 20% equity, a good credit score, and a stable income.

A HELOC has lower costs, interest, and fees, but it’s also riskier than some other options. The lender can cut you off and require full repayment at any time. And if you can’t repay it, you may need to sell the home. This is really only a good option if you are going to stay in the home for a short time, don’t know how much the renovation will cost, or are doing a longer, ongoing renovation.

The Bottom Line

In order to determine the right course of action for you, figure out the budget and length of time for your renovation. Then see which option matches your situation the best and allows you to make the best financial decision, not just for this renovation, but for the future

Arlene Isenburg

Arlene Isenburg