How to Finance Your Home Renovation: From the Most Cost-Effective to the Least
Renovating your property can not only improve its liveabilit and functionality, it can also add 10’s of thousands of dollars’ worth of value to your property.
If not planned correctly, it can potentially turn out to be an expensive endeavour, leaving you with a less than desirable result and a whole lot of extra debt.
Whether you are upgrading your kitchen, adding an extra bathroom, or completely overhauling your property, financing your renovation the right way can save you thousands of dollars.
From leveraging your home’s equity to taking out a personal loan, there are several ways to fund your renovation project. List below are your options, from the most cost-effective to the least.
1. Do a Cash-Out Refinance
A cash-out refinance is often one of the most cost-effective ways to finance your home renovation. It allows you to refinance your existing mortgage for a higher amount than what you currently owe and take the difference as cash.
How It Works:
• You take out a new mortgage that pays off your old loan.
• The new loan is for a larger amount than your current balance.
• You receive the difference in cash to fund your renovations.
Pros:
Lower interest rates compared to personal loans and credit cards.
Longer repayment periods, making monthly payments manageable.
Potentially tax-deductible interest (check with your accountant).
Cons:
Extends your mortgage term or increases your monthly repayments.
Refinancing costs apply, which can include discharge fee, mortgage registration and transfer cost.
Your home is used as collateral, increasing risk if you cannot make payments.
A cash-out refinance is ideal for homeowners who have built up significant equity and want to take advantage of lower interest rates. However, it works best if you plan to stay in your home long enough to recoup the costs.
2. Use Equity to Take Out a Construction Loan (For Major Renovations)
If you are planning a major renovation, such as a full home extension, structural changes, or adding another floor, then a construction loan might be a better option than a simple refinance.
How It Works:
• A construction loan is a short-term loan (typically 12 months) specifically for funding home improvement projects.
• The lender releases funds in stages as renovation milestones are completed.
• Once the renovation is done, the loan can be converted into a standard home loan.
Pros:
Lower interest rates than unsecured loans.
You only pay interest on the amount drawn during construction.
Loan is structured to match your project’s timeline.
Cons:
Requires a detailed renovation plan, build contract and approval from the lender.
Funds are released in stages, meaning you need to manage cash flow carefully.
Higher upfront costs compared to refinancing.
A construction loan is an excellent choice for large-scale projects but requires detailed planning and approval from lenders.
3. Use Savings
The most cost-effective way to finance your home renovation is using your own savings. If you have been setting aside funds for home improvements, this can help you avoid debt and interest charges.
How It Works:
• You pay for your renovation directly from your savings account.
• No need for loan approvals or credit checks.
• You maintain full control over your budget.
Pros:
No interest payments or additional loan costs.
No risk of losing your home or assets.
Immediate access to funds without lengthy application processes.
Cons:
Can deplete your emergency fund.
May not be enough to cover large-scale renovations.
Limits your liquidity, potentially affecting other financial goals.
Using savings is ideal for smaller renovation projects or if you have a well-funded emergency buffer in place.
4. Unsecured Home Improvement Loans
If you don’t want to use your home as collateral, an unsecured home improvement loan could be a viable alternative. These loans are specifically designed for renovations but don’t require you to put up property as security.
How It Works:
• You borrow a fixed amount from a lender without using your home as collateral.
• Repayments are made in fixed installments over a set period.
• Loan terms typically range from 1 to 7 years.
Pros:
No risk of losing your home if you default.
Faster approval and funding process compared to mortgage-based loans.
Fixed repayments make budgeting easier.
Cons:
Higher interest rates compared to secured loans.
Shorter loan terms mean higher monthly repayments.
Limited borrowing capacity depending on your income and credit score.
This is a good option for homeowners who need quick access to funds but don’t want to refinance or use equity.
5. Personal Loan
A personal loan is another unsecured option, though it typically comes with higher interest rates than home improvement loans. This is best suited for smaller projects where you need fast funding.
How It Works:
• You borrow a lump sum from a bank or lender.
• Fixed repayment terms over 1 to 7 years.
• No need for property valuation or equity.
Pros:
Quick access to funds.
No need to use home equity.
Fixed monthly repayments.
Cons:
Higher interest rates than home loans and refinances.
Loan limits may be lower than what you need.
Strict credit requirements for lower interest rates.
Personal loans are best for small to medium renovations that don’t justify the hassle of refinancing or taking out an equity loan.
6. Private Lender
If traditional banks or lenders are not an option, you could turn to a private lender. This is usually a last resort due to higher interest rates and less favourable terms.
How It Works:
• A private individual or company lends you money, often secured against your property.
• Terms and interest rates vary widely.
• Often used for borrowers who do not qualify for traditional loans.
Pros:
Faster approval and fewer requirements than banks.
Can be useful for borrowers with bad credit or irregular income.
More flexibility in repayment structures.
Cons:
Extremely high interest rates (sometimes 10% to 20%+ per annum).
Shorter loan terms with balloon payments.
Higher risk of default leading to potential property loss.
Private lending should only be considered if no other financing options are available and if the renovation project, on completion, has a strong return on investment.
Choosing the Right Financing Option
The best financing option for your home renovation depends on your budget, project size, and financial situation.
| Financing Option | Best For | Interest Rate | Risk Level |
|---|---|---|---|
| Cash-Out Refinance | Major renovations | Low | Medium (uses home as collateral) |
| Construction Loan | Large-scale projects | Medium | Medium (equity required) |
| Savings | Small renovations | None | Low (no debt) |
| Unsecured Home Improvement Loan | Medium-sized projects | Medium-High | Low (no collateral) |
| Personal Loan | Small to medium projects | High | Low (no collateral) |
| Private Lender | Last resort financing | Very High | High (risky terms) |
If you have equity in your home, a cash-out refinance or construction loan is often the most cost-effective option.
However, if you need a smaller amount, using savings or taking an unsecured home improvement loan might be the best route. Private lending should only be used if all else fails.
Lastly, before making a decision, always compare rates, fees, and terms across lenders to find the most affordable solution for your renovation project.