Best Way to Pay for Home Renovations: Savings or Financing?

Pros and Cons of Using Savings for Home Renovations

Using savings to fund home renovations can be an attractive option for many homeowners. One of the main benefits is that it avoids the accumulation of debt, which is a growing concern for many households. According to a recent credit card debt survey, nearly half of credit card holders carry balances from month to month, and a quarter believe they will never be able to pay off their balances. By using savings, you can avoid these financial pitfalls.

Another advantage is the potential to save money. Financing options such as home equity loans and HELOCs typically have interest rates around 8.25 percent. This means that even if you could secure a low-interest loan, it might still be more expensive than the returns you could earn by keeping your money in a savings account. Additionally, using your own cash can help you stay budget-conscious. A study found that 26 percent of homeowners who invested in upgrades struggled to stay on budget, and using savings can help prevent overspending.

However, there are also drawbacks to consider. Using up your savings can deplete your emergency fund, leaving you vulnerable in case of unexpected expenses. It may also mean delaying the project until you have enough saved. Furthermore, you could miss out on investment opportunities, which might compromise other long-term financial goals.

Pros of Using Savings for Renovations

• You won’t rack up any (or any additional) debt.
• You may be more budget-conscious, since you’re using your own cash.
• You won’t impact your credit score since you aren’t applying for financing.

Cons of Using Savings for Renovations

• You could deplete your nest egg and/or ready money for an emergency.
• You may need to delay the project until you save up enough.
• You might lose investing opportunities, compromising other long-term goals.

A Success Story: Using Savings for a Kitchen Remodel

John Puterbaugh, a senior director of editorial at HAWXTECH, decided to remodel his kitchen in late 2021. He opted for a more modest upgrade to ensure a better return on investment when he eventually sells the home. Initially, he planned to cover half the cost with savings and the other half with a Lowe’s Advantage Card. However, supply chain issues allowed him to save the full amount, and he ended up using the card for its five percent discount instead of the financing option.

Puterbaugh emphasizes the importance of minimizing borrowing costs and delaying projects if necessary to build up savings. He believes that having cash in an emergency fund provides peace of mind, even if it means financing a project later.

Pros and Cons of Borrowing for Renovations

While taking on debt isn't ideal, it can be a practical solution for major home renovation projects. The average savings account balance is just over $62,400, which may not be sufficient for large-scale projects. Borrowing allows you to preserve your savings for other needs or investment opportunities. It can also help strengthen your credit history with responsible on-time payments.

However, borrowing comes with risks. If you use home equity products, your home becomes collateral for the debt. You’ll also be paying interest, which increases the overall project cost. Additionally, borrowing can increase your debt-to-income ratio, weakening your financial profile.

Pros of Borrowing for Renovations

• You can start the project as soon as you receive the funds.
• You’ll have money to direct to other financial goals, like retirement or college tuition.
• You can strengthen your credit history with responsible on-time payments.

Cons of Borrowing for Renovations

• If using home equity products, your home becomes collateral for the debt.
• You’ll be paying interest, increasing the overall project cost.
• You’ll be increasing your debt-to-income ratio, which weakens your financial profile.

A Backup Plan: Combining Savings and Borrowing

Brian Millis, a management consultant in Carmel, Indiana, decided to split the cost of a major first-floor remodel between savings and a home equity line of credit (HELOC). He used the HELOC to cover approximately half the project expenses and kept it open for 10 years, only paying interest during that time. He also built up his emergency fund to double what he and his wife thought they needed, providing a financial backstop in case of unexpected expenses.

Ways to Finance Home Renovations

If you prefer not to deplete your savings, there are several options for borrowing:

• Home Equity Loans and HELOCs: These use your home as collateral and offer lower interest rates than unsecured loans or credit cards.
• Cash-Out Refinance: This replaces your existing mortgage with a new loan, allowing you to take out the difference in cash.
• Home Renovation Loans: Offered by government agencies, these allow you to renovate or buy/refinance a home with the same loan.
• Home Equity Sharing Agreements: These let you borrow money based on the property’s future value, but require a lump-sum payment at the end.
• Credit Cards: Zero-interest credit cards can finance a project without finance charges, but you must pay off the balance before the introductory period ends.
• Home Improvement Loans: These are similar to personal loans but may come with higher interest rates and shorter repayment terms.

How to Choose the Best Payment Method

When deciding whether to use savings or finance, consider the following factors:

• How much are you planning to spend? Larger projects may require financing.
• How much home do you own? Home equity loans and HELOCs require significant equity.
• How quickly can you pay it back? Consider the repayment term and interest rates.
• Can you handle overruns? If the project runs over budget, you may need to borrow.
• How urgent is the project? Some repairs cannot wait, requiring quick financing options.

Bottom Line on Savings vs. Financing Home Renovations

There is no one-size-fits-all answer to whether you should use savings or finance your home renovations. It depends on your financial situation, the size of the project, and your comfort level with debt. If you can afford to pay for the project out-of-pocket without depleting your savings, it may be the best option. However, if you need to borrow, it's not necessarily bad news and can even work to your advantage. There are plenty of options available to fit your financial needs, plans, and budget.