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Remodeling? Three Smart Ways to Finance the Project

As you’ve spent more time at home over the past two years, you’ve had considerable opportunity to zero in on its flaws. They might be relatively small – you really need to replace that ‘70s-era shag carpet with hardwoods – or major, as in the only way to create the two remote offices you need is to move some walls.

The tricky question is how to pay for it. Fortunately, there are several financial products that give you access to those funds now and might even streamline your financial life at the same time. Here is everything you need to know about three potential options.

Cash-out refinance

What it is: With a cash-out refinance, you are essentially “cashing out” your existing mortgage and then refinancing your home for a higher dollar amount so you can apply the extra money to your remodeling bills. Here’s how it works: First, you’ll apply for a new loan at an amount that’s higher than your existing mortgage, but still less than your home’s current value. The goal is to have enough money to pay off your first mortgage, with ample funds left to refinance the remodel. Once you’re approved for the new loan, you’ll pay off your first mortgage and then use the rest of the cash to cover your remodel. With the new mortgage in place, you’ll continue paying on it as usual.

Who it’s best for: This is a wise strategy if you have a lot of equity in your house. For most families, that increased home value is the largest financial asset they have, yet it’s not liquid in a way they can use it to pay for home improvements, except through a maneuver like a cash-out refinance. This financial move might even allow you to lower your monthly payment while still having funds for your remodel, and also let you take advantage of an interest rate on your new mortgage that’s lower than your current one.

Home equity loan and home equity line of credit 

What it is: There are two ways to tap the equity in your home without having to sell it: a home equity loan and a home equity line of credit (HELOC). Both of these products allow you to borrow money against the equity you have built up in your home. The amount you qualify for will be based on how much equity you have in your home – as in, the home’s current value minus what you owe on your mortgage.

But while they are similar in concept, they function very differently. You’ll access a home equity loan as a lump sum of money you borrow all at once, which means you’ll pay interest on the entire amount, even if you’re not using it all. With a HELOC, the entire line of credit is available, but you don’t have to take the total amount you were approved for in one big payment. Instead, you can tap it on an as-needed basis. So for example, if you decide to borrow $20,000 to update your kitchen, you can borrow that exact amount — even if you were initially approved for $50,000. That means you’ll only be paying interest on the amount you’re using at any given time, rather than the entire amount you were offered.

Because the interest rate on these financial products is typically lower than a credit card, it’s usually a better option than laying down your plastic. With a home equity loan, you’ll make fixed monthly payments for the extent of its term, which typically ranges from five to 15 years. A HELOC has an indexed interest rate, but you can also choose to lock it in. 

Who it’s best for: Since both of these products operate as a second mortgage, they can be a better choice for someone who doesn’t want to go through the hassle or expense of getting a new mortgage as you would through a cash-out refinance. They also can be the right choice if you’re currently in a mortgage product you really like, such as one that already has a very low-interest rate. Your First Midwest lender can walk you through those options to choose the product that’s right for your goals and financial situation.

Personal loan

What it is: A personal loan is another kind of loan, but unlike a home equity loan, it’s not based on the value of your home. Often the lender will check your credit to determine the amount for which you qualify. While credit cards are “revolving” loans with variable interest rates and ongoing payments, a personal loan is an “installment” loan, which means it will have fixed interest and term limits.

Who it’s best for: If you haven't built enough equity in your home yet to qualify for a home equity loan, a personal loan can be a good choice. It typically will have a lower interest rate than a credit card, and it’s easy to manage with one fixed payment for a designated term that usually ranges from one to seven years. Many people find that a personal loan is preferable to adding more charges on a credit card where your payment amount could increase every month.   

Which product is right for you?

Ready to get started on that project to turn your property into the “home sweet home” of your dreams?  As with any financial decision, the best route for you depends on your current financial situation and your needs and goals. Before taking out any type of loan, make sure you understand the implications for your overall finances, such as how it might affect your credit and the amount and term length of the payments. You can also learn more about your borrowing options at firstmidwest.com.

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