Whether you just bought a house with pre-existing paneling or you installed the paneling yourself, changing circumstances bring new design attitudes, and it may be time for the paneling to go. Tearing it out is a big job, and it usually isn't necessary, because you can finish almost any paneling with a coat of paint or a layer of wallpaper. Wallpaper hides defects in the paneling better than paint, but it takes preparation.
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Before you go to the trouble of preparing your paneling for wallpaper, take the time to look for mold, especially around the top and bottom edges. If you find any, it may be safer to discard the paneling, especially if the wall has gotten wet from leaks. If it is mold-free, prepare the paneling by filling voids with drywall joint compound or wood filler and caulking visible seams between panels with flexible, paintable caulk. Remove all the trim, including crown molding and baseboards, and pound in any nails that are sticking out. If any panels are loose, reattach them to the studs with ring-shank finish nails.
Preparing Smooth Paneling
After making preliminary repairs and sanding any filler, smooth down rough-sawn paneling by sanding with 120-grit sandpaper. It's a big job, but if you don't do it, the wallpaper may ripple and bubble. Your smooth unfinished wood paneling may only need a light once-over with dish detergent and water, but if you have hardboard or MDF paneling with a glossy finish -- which is more common -- wash it with a cup of trisodium phosphate per gallon of water to etch the finish; then scuff it with 220-grit sandpaper. Complete the preparation with wood primer: one coat for finished paneling and two for unfinished.
Before papering over grooved paneling, you need to bring the grooves level with the wall, or they'll show up under the paper. The most effective way to do this is to skim coat, which is a process whereby you spread drywall joint compound over the entire wall and scrape it flat with a drywall blade. Apply mud only after you've primed the paneling, and don't try to get perfect results with the first application; it will probably take two or three passes. Sand the final coat after it dries with 120-grit sandpaper attached to a pole sander; then wipe dust off the wall and prime again -- this time with PVA primer.
Apply Sizing and a Liner, Then Hang the Wallpaper
After the last coat of primer dries, apply a coat of wallpaper sizing, which is a water-based product that forms an extra layer to which the wallpaper adhesive can stick. You apply sizing with a brush, and you can tint it the same color as the wallpaper to prevent lifting seams from showing a white wall. After the sizing dries, hang a heavy-duty wallpaper liner -- it should hang horizontally to prevent overlaps with the paneling seams. As soon as the liner adhesive dries, you're ready to hang the wallpaper vertically, using the adhesive, tools and techniques recommended by the manufacturer.