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Home Improvement Loans: How To Finance Home Renovations

7-Minute Read
Published on August 4, 2021
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Making changes to your home can be expensive, and not everyone can afford to make those changes out of pocket.

This is where home improvement loans come in. These loans can help you afford the upfront cost of big updates or repairs that make your home safer, more livable or more enjoyable. However, anytime you consider borrowing money, it’s important to ensure you can ultimately afford to take out the loan and that you pick the best loan type for your needs.

Here’s everything hopeful home renovators need to know about home improvement loans.

What Are Home Improvement, Or Home Remodel, Loans?

A home improvement loan is usually an unsecured personal loan that a borrower uses for updates, upgrades or other small projects on their home. However, these types of loans can come from several sources. Cash-out refinances are a great example, as they allow homeowners to use the equity in their homes to fund larger projects. 

Outside of personal loans and cash out refinances, homeowners have options in home equity lines of credit (HELOC) and second mortgages.

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How Do Home Improvement Loans Work?

As the name suggests, home improvement loans can help finance home improvement projects or other renovations in a home.

No matter what type of loan you get, the general workings are the same: you apply and are approved for a loan, the lender gives you the money and you pay the lender back with interest. When you get a home improvement personal loan, for example, your lender will deposit the amount you’re borrowing into your bank account. You’ll immediately begin paying back that loan on a monthly basis.

Once you receive the money from your lender, you can begin paying for expenses related to your home improvement project, such as tools, supplies or labor.

Should You Use A Personal Loan For Home Improvement Projects?

A personal loan used for home improvement is typically the most unsecured form of debt. It’s different from other home improvement loan options because it’s not backed by the collateral of your home. Like a credit card, your rate will depend on your creditworthiness. Rates on these types of loans are typically fixed. This means your payment won’t change and you’ll be able to easily budget for the payment with your other expenses.

You might want to get a personal loan for your home improvements if:

  • You don’t have much equity in your home
  • The project is relatively small
  • You can pay off the debt within a shorter time frame (3 – 7 years)

A personal loan may not be the right choice for you if your home improvement goals require a large sum of money. Personal loans typically have higher rates and shorter loan terms than a second mortgage or cash-out refinance, so your payments may be less affordable than with other options.

For example, let’s say a person with excellent credit is approved for a $20,000 personal loan for a home repair. Their rate is an average 13% and they’re required to pay it back in 5 years. That brings their payment to over $450 each month. A monthly payment this size might be difficult for some.

If you feel a personal loan is the right choice for your home improvement needs, visit Rocket Loans℠ for more information on how to apply and get started.

Personal Loan Pros And Cons

Pros

Cons

No collateral requirements

Potentially higher interest rates compared to secured loans

No home equity required

Lenders may have higher credit score requirements

Funds reach your bank account quickly

Shorter repayment term means higher monthly payments

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Should You Use A Cash-Out Refinance For Home Improvement Projects?

If your current mortgage interest rate is higher than the average market rate and you have equity in your property, you might want to use a cash-out refinance for your home improvements. This means that you’ll refinance your existing mortgage and convert the equity in your home to cash.

Not only can this adjust your current mortgage to more favorable and affordable terms, but it’ll also give you the money you need to pay for your home improvements without having to take on a separate loan.

If current market rates are higher than your current loan terms, a cash-out refinance might not be the best option for you. Even though you’ll be able to dip into the equity in your property, it would mean paying more interest on the rest of your loan balance for the remainder of your term.

If you think a cash-out refinance could be the right choice for you, the next step is to get approved.

Cash-Out Refinance Pros And Cons

Pros

Cons

No second mortgage required

Closing costs

Relatively low interest rates

Requires existing home equity

Long repayment period 

Risk of foreclosure

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Other Types Of Home Improvement Loans

Although home improvement loans most often refer to personal loans, home renovators can also use other types of loans to finance their home improvements. Each has its own pros, cons and intricacies you’ll want to consider before determining which one is best for you.

Here are some of the most popular types of loans that are used to finance home improvement projects.

Home Equity Loan

A second mortgage, also known as a home equity loan, is just what it sounds like. It’s another mortgage that acts as a second lien on your property. Your second mortgage lender will provide you with a large lump sum that you pay back over a specific amount of time. With each payment, you pay a portion of your loan balance and interest. 

Home equity loans typically have fixed interest rates, and your rate and term will depend on your credit and employment history, just like when you applied for your first mortgage. There may be limits set by lenders or investors in the loan regarding how much of your existing equity you can take a loan against but it is possible to refinance a second mortgage.

This can be a good option for those seeking home improvements because it can get you a lot of money that you can spend however you need. You can deduct mortgage interest on a second mortgage if the funds are used for home improvements, so you’ll see additional savings when you file your taxes for the year.

The drawback of a second mortgage is that it’s an additional lien on your home and comes with a higher rate due to risk (if there’s a hardship, lenders assume you’re going to make the payment on your primary mortgage first). If it goes unpaid, you’ll risk possible foreclosure action and legal consequences. If you’re concerned about added risk to your home, this may not be the right option for your home improvement goals.

Rocket Mortgage® doesn’t offer home equity loans at this time.

Home Equity Loan Pros And Cons

Pros

Cons

Consistent monthly mortgage payments

Additional lien on your home

Large, lump sum of cash

Higher interest rates

Tax deductible mortgage interest

Risk of foreclosure

Home Equity Line Of Credit (HELOC)

A home equity line of credit, or HELOC, allows you to borrow money by using your home’s equity as collateral. Your lender will set a borrowing limit. You can take as much money from the line as you need, pay it off and borrow again within an agreed upon time frame, known as the draw period (typically 10 years). The interest rate is fixed for a certain period of time, and then it will adjust up or down based on market conditions for the remainder of the loan term.

During the draw period, you only pay interest on the equity you use. This may be the only payment you make during the draw period as you may not be required to pay toward principal at that time. Once the draw period is over, you’ll enter the repayment period.

If you’re considering a large renovation and aren’t totally sure how much it will cost, a HELOC might be a good option for you. For example, if you decide to redo your kitchen, a contractor may quote you an initial estimate of $10,000. But, as time goes on, you may run into issues with repairs or decide on different paint, cabinetry or other extras for the room. A $10,000 estimate could easily double in this case. A HELOC may help you out and allow you to borrow as needed.

If you’re certain how much you’ll need for your home repairs, a traditional second mortgage or cash-out refinance may be a better choice. In that situation, you’ll have one lump sum, allowing you to complete your renovations and pay the loan back in a straightforward manner.

Like home equity loans, many HELOCs aren’t tax-deductible after the 2017 tax year unless you use them toward projects around the house. If you have any doubts, always contact a tax advisor.

Rocket Mortgage doesn’t offer HELOCs at this time.

Home Equity Line Of Credit Pros And Cons

Pros

Cons

Borrow as you need over time

Reduced tax benefits after 2017

Low upfront costs

Interest rates are usually adjustable during repayment period

Typically lower interest rates than personal loans

Home is used as collateral

How To Get A Home Improvement Loan

After you’ve determined what type of home improvement loan is best for you, you can begin shopping around at different lenders that offer the type of loan you’re looking for.

The requirements for getting a loan will depend on what type of loan you get and the lender’s individual requirements. For a personal loan, a lender might have specific credit score and debt-to-income ratio limits for borrowers. For a loan that’s tied to your home, such as a cash-out refinance, you may also need an appraisal.

Here are a few strategies to get you started.

Compare Home Improvement Loan Rates

Shopping around and getting rates from multiple lenders is also important if you want to get a good rate, because it allows you to compare offers and ensure you get the best deal available. Before choosing the best mortgage lender, be sure you’re comparing rates for comparable loan products, looking at the interest rate and APR the lender offers and considering the type of loan you want.

Know What Credit Score You’ll Need To Qualify

As with other loan types, the best way to get a good rate on your home improvement loan is to minimize the risk you pose to lenders as a borrower. This means having a good credit score and keeping your overall amount of debt low compared to your income.

Some lenders offer loans to borrowers with less-than-ideal credit, but your options might be more limited and the loan will likely come with a relatively high interest rate.

Look Into Financial Assistance Programs

For many, the upfront costs of refinancing or the monthly payments of a second loan could make qualifying for a home improvement loan challenging. 

If you’re struggling to get a home improvement loan but are in need of assistance to upgrade or repair your home, you might want to explore any home improvement grants and programs that are available to you.

The Bottom Line: There’s More Than One Way To Finance Your Next Project

Although many people use the term “home improvement loan” to refer to a personal loan, there are other loan options available that may better suit your home renovation needs. As you make your decision, consider how much your monthly payment will be, how much flexibility you need in the loan amount and what loan terms work best for your financial situation. 

If you're looking to fund a small project, you might consider getting a personal loan from Rocket Loans

Looking to fund something bigger? Rocket Mortgage offers cash-out refinancing to homeowners who want to leverage their equity for home renovations. Get preapproved now to fund your next project.

Fund your renovations with a cash-out refinance.

Get approved online now!

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Victoria Araj

Victoria Araj is a Section Editor for Rocket Mortgage and held roles in mortgage banking, public relations and more in her 15+ years with the company. She holds a bachelor’s degree in journalism with an emphasis in political science from Michigan State University, and a master’s degree in public administration from the University of Michigan.