If you want to upgrade your home but need help funding the costs, a home improvement loan could be an excellent solution. Each home improvement loan works differently, so you’ll need to choose the one that best fits your finances and goals.
Key Takeaways:
- If you want to renovate your home and are exploring financing options, a home improvement loan may be a viable resource.
- There are several types of home improvement loans, including secured and unsecured loans, which can be used for different reasons.
- When searching for the best home improvement loan for you, consider your goals and financial situation, and compare rates and terms across multiple lenders.
What Are Home Improvement Loans?
Home improvement loans can help you pay for either minor or major home upgrades, like painting the exterior, building an addition or replacing a roof.
Some home improvement loans are secured, while others are unsecured. Secured loans require the borrower to provide collateral, whereas unsecured loans do not.
Home Renovation Loans Vs. Home Equity Financing
Home equity is the difference between what your home is worth and what you owe on it. Homeowners can borrow against their equity to pay for home improvements.
The most common types of such loans are home equity loans and home equity lines of credit (HELOCs).
Because they’re secured loans that use your home as collateral, they typically have lower interest rates. But if you default on the loan, you could lose your home.
A home renovation loan, on the other hand, is typically a type of personal loan used to finance home improvements. Personal loans tend to come with higher interest rates, but since the loan is unsecured, you’re not putting your personal property at risk.
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How Do Home Improvement Loans Work?
Some financing options are specifically designed for home improvements, while others can be used for any purpose, including home improvements.
One option is an installment loan, where you receive a lump sum of money and repay it in installments. Another is a line of credit, which you can access as needed.
Installment loans typically have a fixed interest rate, so your monthly payment remains constant. Once you’ve repaid an installment loan, your account with that lender is closed. A cash-out refinance and a personal loan are both installment loans.
A line of credit, meanwhile, lets you borrow cash as needed, and you repay only what you borrow. Most lines of credit have variable interest rates.
Installment loans could be best for homeowners who know exactly how much they plan to spend.
A line of credit, on the other hand, could be better suited for borrowers who are unsure of their financing needs or for those planning multiple home improvement projects with fluctuating costs.
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6 Home Improvement Loan Options
Which loan options are available to fund your home improvement project? Here are six options for home improvement loans:
1. Cash-Out Refinance
A cash-out refinance replaces your current mortgage with a new one. Here’s how it works:
- Take out a new, larger mortgage by tapping into your home equity.
- Use a portion of the funds to pay off your existing mortgage.
- Receive the difference in cash.
You can use the funds for any reason, including home improvements or debt consolidation.
Lenders typically will not let you borrow more than 80% of your home’s value with a cash-out refinance. However, a VA refinance loan may allow borrowers to access 100% of their home’s appraised value. The rates and terms you receive will depend on your credit score and debt-to-income ratio.
2. Home Equity Loan
A home equity loan is a second mortgage that you can use for home renovations. You borrow against your home equity as a lump sum, then repay what you borrow in monthly installments. Home equity loans have fixed rates and loan terms ranging from five to 30 years.
The interest rate for a home equity loan will be lower than what you’d get with a personal loan, but you’ll also have two monthly mortgage payments. You can deduct the mortgage interest on a second mortgage from your taxes if the funds are used for home improvements.
3. Home Equity Line Of Credit
A home equity line of credit is another way to access your home equity without refinancing your primary mortgage. With a HELOC, your borrowed equity becomes the basis for a line of credit that you can draw on as often and for as much as you need.
HELOCs typically have a draw period of approximately 10 years, during which you can borrow against the credit line and pay interest on the amount borrowed. Once the draw period ends, you can no longer withdraw funds, and you begin repaying the principal and interest.
The repayment period is much longer and can last up to 20 years. A HELOC is an ideal choice if you’re unsure of the cost of a home improvement project or if you plan to complete multiple projects.
4. FHA 203(k) Loan
The Federal Housing Administration offers FHA 203(k) rehabilitation loans to help low- and moderate-income borrowers purchase homes that need repairs.
There are two types: the limited 203(k) and the standard 203(k). A limited 203(k) is best suited for homes requiring minimal repairs, and the home must remain habitable during the renovation. Limited 203(k) loans are capped at $75,000.
A standard 203(k) applies to homes that need significant structural or systemic repairs, such as plumbing upgrades, new heating and cooling systems or kitchen renovations. The minimum loan amount is $5,000, and there’s no maximum loan amount. The property’s value must meet FHA loan limits for that area.
5. Fannie Mae HomeStyle® Renovation Loan
A Fannie Mae HomeStyle® loan lets you buy or refinance a home and pay for renovations and closing costs with one loan. The interest rate you’ll receive is typically lower than that of a HELOC, personal loan, or credit card.
6. Personal Loan
Personal loans are unsecured loans that can be used for various purposes, including home improvements. They come with a fixed interest rate, and most of them have repayment terms ranging from 3 – 7 years.
Personal loans are best suited for small home improvement projects that you can afford to repay quickly. Due to the relatively short repayment terms, personal loans tend not to be the best choice for borrowers who need to borrow large sums.
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Pros And Cons Of Home Renovation Loans
Consider these advantages and drawbacks of home improvement loans:
Pros
- Increase your home’s value: Home improvements can boost your property value, which can be an asset if you plan to sell in the future.
- Convenience: A home improvement personal loan can streamline the financing process if the homeowner’s other financial alternative was to pay for renovations via multiple credit cards. You’ll repay one lender each month instead of juggling multiple lenders and payments.
- Flexibility: Home improvement loans let homeowners use their funds for renovations, repairs, or home expansion projects.
Cons
- You’ll take on more debt: A home improvement loan will add to your total debt, so if you’re not careful, you could overextend yourself financially.
- Some loans put your home at risk: If you take out a secured loan, like a HELOC or home equity loan, you’re at risk of losing your home if you’re unable to repay it.
- Higher interest rates: An unsecured loan, such as a personal loan or credit card, comes with a higher interest rate, increasing the amount you have to pay over the life of the loan.
Comparing The Best Home Improvement Loans
Here are some factors to consider when comparing home improvement loan options:
- Annual percentage rate (APR): Your APR is expressed as a percentage, and it calculates the total amount you’ll pay, including interest and fees. A higher APR means you’ll pay more over the life of the loan.
- Total loan amount: The total loan amount is the principal you borrow to finance your home improvements. A higher loan amount means more debt and that it will take longer to repay.
- Length of the loan term: The loan term is how long your lender gives you to repay the home improvement loan. A longer loan term will result in lower monthly payments, but you’ll pay more overall in interest.
- Monthly payment amount: This is the amount you must pay on your loan each month. You want to ensure that the monthly payment amount aligns with your budget.
- Additional fees: Verify whether the lender charges extra fees, like closing costs, an origination fee or a prepayment penalty.
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Getting A Home Improvement Loan
Once you’ve decided which home improvement loan is right for your situation, use this step-by-step guide to start the process:
1. Check Your Credit Score
Your credit score largely determines the interest rate and loan terms you’ll receive on your home improvement loan. Before applying for a loan, check your credit score so you know where your credit stands.
2. Review Your Home Equity
Borrowers with more home equity have more options for financing. You can determine how much equity you have in your home by comparing the appraised value to how much you owe on your mortgage. A home equity loan or HELOC may be ideal if you have at least 20% equity.
3. Compare Your Financing Options
Once you know the type of loan you want, gather quotes from at least three lenders. Comparing your financing options will help you zero in on the best rates and terms. During this stage, lenders will perform a soft inquiry on your credit, which won’t impact your credit score.
4. Submit An Application
Once you’ve picked a lender, submit an application. When you apply, your lender will ask for additional documentation to verify your income and employment.
5. Repay The Funds You Borrow
Once you’ve received the loan proceeds, you’ll begin repaying the home improvement loan. On a HELOC, you’re required to pay interest for the first 10 years only. This means you may need to budget for a balloon payment or for higher payments (once principal payments begin) in the future.
FAQ
Here are answers to common questions about finding the best home improvement loans:
The Bottom Line: Home Improvement Loans Can Help You Fund Updates That Boost Your Home’s Value
Home improvement loans are a convenient and affordable way to finance renovations and repairs. While you can choose from many different loan types, be sure to consider your financial situation and goals to determine which home improvement loan is right for you.
Natasha Etzel
Natasha Etzel is a financial writer with over a decade of experience. She has covered various financial topics, including mortgages, personal loans, home equity loans, debt consolidation, and refinancing. She writes for financial companies, including mortgage lenders, and various publications, including NerdWallet, Newsweek, The Motley Fool, and more.
