What are HELOCs and HELs? Considering a renovation? Let’s explore five effective ways to fund your project.

What are HELOCs and HELs? If you’re contemplating a home makeover, understanding your financing options is crucial. From tapping into retirement funds to leveraging credit, each method has its pros and cons.

Research from the Harvard Joint Center for Housing Studies estimates that U.S. spending on home renovations will hit $509 billion by 2025, up from $487 billion in 2023. Before you start your renovation journey, carefully assess which funding sources are right for you. Look beyond just accessibility and interest rates—consider loan terms, taxes, and potential repayment challenges.

Here’s a breakdown of various financing options for your home upgrade:

Is borrowing from your 401(k) a wise move for renovations?

Many find it tempting to take a loan from their employer-sponsored retirement accounts, like a 401(k) or 403(b), especially if they’ve amassed a significant balance. According to Fidelity, more individuals than ever are now 401(k) millionaires. However, think twice before accessing these funds.

Using this tax-advantaged account can be risky unless you have ample retirement savings, says Melanie Nichols, a financial planner.

Key point: “Using your 401(k) for renovations may hinder your retirement savings growth,” warns Tendayi Kapfidze, chief economist at LendingTree. While it might seem appealing to pay yourself interest, you could miss out on more substantial returns from your investments. Also, during the repayment period, many stop contributing to their retirement accounts, losing potential tax benefits and employer matches.

Another factor to consider is job security; if you switch jobs, the loan becomes due almost immediately. Failure to repay could lead to penalties and taxes.

Could a cash-out refinance be a solution for funding renovations?

A cash-out refinance allows you to consolidate your existing mortgage balance with additional funds for renovations into a new loan. The same interest rate applies to all borrowed funds, and if you itemize deductions, the interest could be tax-deductible.

Key point: With this option, your home serves as collateral. If you encounter financial hardships, such as job loss, foreclosure on your home is a possibility. Additionally, the process of obtaining cash may take longer due to necessary appraisals, so plan accordingly. Don’t overlook the costs associated with refinancing, including closing and origination fees.

What’s a HELOC? What’s a HEL? Are they right for you?

Home equity loans and lines of credit are alternatives for funding renovations. A home equity loan (HEL) functions as a second mortgage with a fixed interest rate, providing a lump sum upfront. You’ll need a clear understanding of your renovation costs to determine the amount to borrow, as noted by Kapfidze.

A HELOC, or home equity line of credit, offers a credit line that allows you to borrow as needed. You only pay interest on the funds you use, but the variable interest rates can complicate budgeting.

Key point: Be cautious—using your home as collateral carries risks. Both HELs and HELOCs have strict equity requirements, and a high credit score is necessary for approval.

Is a personal loan a viable option for home improvements?

Personal loans from banks, credit unions, or online lenders don’t require collateral and can deliver cash quickly. Interest rates vary based on credit history, ranging from around 7% to over 30%.

Key point: Since personal loans typically have higher interest rates than HELs or HELOCs, they’re better suited for smaller renovation projects. Always compare loan terms and fees before committing.

Can a credit card be used for home renovations?

While many credit cards come with high-interest rates for balances, strategically using them can be beneficial. Some cards offer interest-free financing for extended periods, as noted by Matt Schulz, chief credit analyst at LendingTree.

Key point: If you can’t repay your balance during the promotional period, consider other financing options. These offers often include deferred interest clauses, which can lead to unexpected costs if your balance isn’t paid in full.

Cash remains the best option for funding home upgrades.

We’ve examined various financing methods, including HELOCs and borrowing from retirement accounts. However, if you can afford it, paying cash is often the wisest choice. It might be challenging to save for your dream renovation, but if you can wait, it’s worth it.

“Taking time to save for a project is far better than accruing debt,” Schulz emphasizes. “While it’s tempting to pursue flashy renovations immediately, it’s not worth incurring crippling debt.”

Delaying your project by several months or even a year can help you save, especially if you’re not in a rush to sell your home.