What's Best Way to Pay for Home Improvements? Cash vs. Equity

5 min read

Let’s face it, after a while that new home you bought a year, five years, or even ten years ago may start to lose its luster. Your tastes may have changed, or you simply have different needs such as needing a dedicated home office to work from home.

Whatever the reason, improving your home is a great way to help it retain its value. It can also help you net more money whenever you decide to sell. Furthermore, completing home renovations can help make your home a more enjoyable place to live.

However, it comes as no surprise that home improvements cost money. While simple projects might run you hundreds of dollars, more extensive renovations may cost thousands. Thus, it may be more prudent to focus on improvements that have a higher return on your investment.

Additionally, paying these costs out of pocket instead of borrowing money could save you money in terms of accrued interest in the long run, but it can also decrease your available cash on hand that could be used for other purposes or in case of an emergency.

An alternative to using cash is tapping into the available equity in your home. This can be a great way to pay for upgrades and improvements but may require additional hoops to jump through.

If you are considering renovating your home, but are unsure which improvements have the most bang for their buck or how to finance your project, here are a few factors to consider.

Should You Use Equity or Pay Cash?

One of the cheapest ways to pay for renovations is to use cash or personal savings. This is because you aren’t taking on any more debt that accrues interest over time. You also don’t have to pay any additional fees to obtain new financing.

However, the mistake many homeowners make is paying too much out of pocket and overextending their budget. It's always important to keep some cash on hand or in reserves to cover unexpected expenses that life might throw your way.

Additionally, there is an opportunity cost to consider. That cash might be better invested elsewhere where it could earn a higher return on investment (so long as you account then for the costs to finance your project into your global rate of return).

For example, over the past 10 years, the average stock market return has been around 9.2% according to Goldman Sachs¹.

On the other hand, mortgage rates are near all-time record lows. Most recently the average U.S. 30-year fixed rate mortgage fell to 3.03%². Using debt to finance home renovations is currently cheaper than it has in past years.

Similarly, recent data has found that on average homeowners gained roughly $33,400 in equity in the first quarter of 2021³. This is one of the highest annual gains per borrower in the last 10 years, meaning you might have access to borrow additional funds³.

If you don’t want to use up all your available cash, leveraging the available equity in your home could be a wise choice if you leverage the current interest rate environment.

Projects With the Highest Return on Investment

Reinvesting equity into our home can be easy if you focus on home renovation projects that have been proven to have a higher return on investment.

While many people might try to focus attention on refinishing interior spaces, data has found that five out of the six top home improvements projects for 2021 with the highest return on investment were exterior renovations⁴.

For example, by replacing a garage door or installing stone veneer siding on part of your home, such as the entryway or lower front-facing exterior, you could recoup over 90% of your investment⁴.

Installing new windows or an entry way door will also give you a lot of bang for your buck. Projects can help enhance your home’s curb appeal, making it more attractive to potential buyers.

If you are set on doing interior renovations, focusing on the kitchen area can prove to be ideal. The cost of a minor kitchen remodel can vary depending on what you are upgrading or changing, but on average expect to pay around $25,000⁴.

This cost includes changing cabinets, countertops, and even installing new hardware. It also covers replacing dated appliances as well as adding new flooring and paint⁴.

Surprisingly, projects with the worst return on investment include adding another bathroom or addition to your master suite. Overall, these projects offer less payback on average⁵.

Sources

¹ Knueven, L. (2021, June 14). The average stock market return over the past 10 years. Retrieved September 8, 2021, from https://www.businessinsider.com/personal-finance/average-stock-market-return

² Ostrowski, J. (2021, September 01). Mortgage Rates Edge Down Again, Hover Near Historic Lows. Retrieved September 8, 2021, from https://www.bankrate.com/mortgages/analysis/

³ Bondarenko, V. (2021, June 09). Average homeowner gained $33,400 in equity last year. Retrieved September 8, 2021, from https://www.inman.com/2021/06/10/average-homeowner-gained-33400-in-equity-last-year-corelogic/

⁴ Franklin, J. B. (2021, May 18). Best Home Renovations That Return The Most At Resale. Retrieved September 8, 2021, from https://www.bankrate.com/real-estate/home-renovations-that-return-the-most-at-resale/

⁵ Voorhis, S. V. (2019, March 11). Six Best and Worst Home Improvements for Your Money. Retrieved September 8, 2021, from https://www.thestreet.com/personal-finance/real-estate/six-best-and-worst-home-improvements-for-your-money-14864740#gid=ci0256b267d0002716&pid=no-1-worst-home-improvement-upscale-master-suite-addition-roi-504