One of the nice things about home improvement projects is that they give you something back for your investment. While the cost of these projects--supplies, labor, and home improvement loan interest--can seem daunting, you do get some return in the form of value added to your home. The payback of home improvement projects is dependent upon two things: the nature of the project, and the form of financing used.  

Project Payback

Think about four major types of home improvement projects:

• Additions--projects which directly add to the square footage of your living space.
• Maintenance and Physical Upgrades--projects that make your home more sound, such as replacing a roof or upgrading windows.
• Cosmetic changes--renovations to make the home more attractive.
• New features--adding things such as a deck, pool, or Jacuzzi that increase your enjoyment of the home.

Of these, the first three add to the value of a home most reliably. After all, square footage and the number of bedrooms and bathrooms directly affect the way homes are priced. The overall condition of a home can also dramatically add--or subtract--from its value. Finally, those cosmetic changes not only impact what people think the house is worth, but they may be the determining factor in how easy it is to sell the home.

As for those new features, they may be more of a gamble. Not everyone wants the same extras, and some people view a feature like a pool to be a drawback because of the maintenance and liability involved.

Refinance, Home Equity Loan, or Other Source of Financing?

Your method of financing the project also factors into the return on investment, since it will determine interest costs. Home improvement loans can take many forms:

• You can refinance your existing mortgage. The decision to refinance will depend largely on a comparison of mortgage rates, but since primary mortgages typically have the lowest interest rates, you may want to tap into home equity by refinancing your mortgage for an amount exceeding your current remaining balance.
• If you do not want to refinance your existing mortgage, consider a second mortgage, such as a home equity loan. Typically, a second mortgage will carry a higher interest rate than a primary mortgage, but should still be cheaper than an unsecured loan.
• As an alternative form of home equity loan, consider a home equity line of credit (HELOC). Like a home equity loan, a home equity line of credit is based on your available home equity. However, while a conventional home equity loan requires you to pay interest on the money immediately, a home equity line of credit only charges you interest on the amount of available credit that you actually use.

Different forms of home improvement loan are optimal depending on the circumstances. If interest rate considerations are clearly favorable, it may be best to refinance your existing mortgage. Otherwise, leave that mortgage in place and consider a second mortgage, such as a home equity loan or a home equity line of credit. Finally, since any form of home equity loan uses your home as collateral, be sure to budget before you borrow!