Using A Personal Loan For Home Improvement: Pros, Cons and Alternatives
Whether you’re scrambling to fix the leaky roof of a 100-year-old home you recently moved into or you’re eager to remodel part of your house, home improvement project costs can break the bank. If you have little equity or need a quick turnaround time for the funding, a personal loan is a customizable solution to fund your project in as little as one business day. Here’s how to qualify for a personal loan for home improvement projects and ensure that it’s your best option to get the job done.
What Is A Personal Loan For Home Improvement?
When you need financing for home renovations, repairs, or upgrades to your home, a personal loan is an accessible choice. These loans are typically unsecured, meaning they don't require collateral such as a house or car to secure the loan. The borrower receives a lump sum upfront, which they can use for any desired home improvement.
Remember, personal loans aren't solely for home improvements; borrowers can use them for any purpose. So, when you see an advertisement for a home improvement or home renovation loan, it's usually a personal loan unless stated otherwise.
Additionally, while a personal loan's versatility is helpful to fund a home improvement project, other financing options may be more suitable depending on your circumstances. Most other options use your home as collateral, helping you obtain a lower interest rate. In the next sections, you'll learn how to pick which of these options is best for you.
Is A Personal Loan For Home Renovations Right For Me?
The current lending market is continuing to see higher interest rates for all types of debt. While rates have fallen from recent highs, borrowing money remains more expensive than 2 or 3 years ago. In any lending market, personal loans have higher interest rates than other loan types. As a result, while personal loans are quicker to qualify for and obtain, they’re more expensive. For instance, personal loans have interest rates as high as 36% – more than some credit cards.
Personal loans have higher interest rates because they don’t use collateral. Lenders charge more in interest to cover their risk in lending. On the other hand, cash-out refinances, home equity loans, and home equity lines of credit (HELOCs) use your home as collateral, thereby reducing interest rates. In today’s market, lowering the cost of borrowing is crucial for most homeowners.
However, a strong credit profile can help your lender see you as a low-risk borrower for a personal loan. For instance, if you have excellent credit (a score of 700 or higher), you could qualify for a personal loan with a 7% or 8% interest rate.
Additionally, your other loan options require equity to access. Specifically, you’ll need more than 20% equity in your home to qualify for a home equity loan or a HELOC. Likewise, a cash-out refinance won’t provide sufficient cash unless you’ve put a dent in your mortgage. So, a personal loan is more suitable for new homeowners who haven’t had the chance to build equity.
Here’s a summary of the factors where a personal loan might be the right choice:
- You have a good credit score and can qualify for a competitive rate
- You think you can pay the loan back relatively quickly
- You have 15% or less equity in your home
- You only need a few thousand dollars for the project
Home Improvement Personal Loans Pros And Cons
If you go with a personal loan, here are the pros and cons to keep in mind.
Personal Loan Pros
Here’s how using a personal loan for home improvement projects is beneficial:
- Competitive interest rates: You can get a competitive interest rate on a personal loan as a borrower with good credit. To do so, build an impressive credit history by paying your debts on time and keeping a low debt-to-credit utilization ratio.
- Adjustable repayment terms: Personal loan terms and rates vary among lenders. So, it’s best to shop around for a loan with a repayment period that fits your situation. For instance, some personal loans give borrowers three years to repay, while others give seven years. Longer repayment means a lower monthly payment but increased overall interest costs.
- Fast funding: You can get a personal loan within a week with lenders who work quickly. Conversely, home equity loans and HELOCs can take 2 weeks to 2 months.
- Unsecured debt: Personal loans are unsecured loans, meaning they don’t require collateral. Remember, using your home as collateral means risking foreclosure if you fall behind on payments. On the other hand, falling behind on an unsecured loan won’t result in the loss of property.
- Lower closing costs: Personal loans usually have origination fees and closing costs of 1% to 5% of the loan amount. Additionally, many lenders waive origination fees to make personal loans more attractive. Other loan products have closing costs of 2% to 6%.
Personal Loan Cons
Here are the drawbacks of using a personal loan for home improvements:
- Prepayment penalties: Some lenders charge penalty fees if borrowers pay back their loan early. For example, if you have a 5-year loan term, paying it off in 3 years will incur a fee to compensate the lender for lost interest. Some lenders offer personal loans without prepayment penalties, so it’s crucial to review the loan terms and details before signing.
- Higher interest rates: Interest rates are higher for unsecured loans versus secured loans because lenders charge more to compensate for the lack of collateral.
- Stricter eligibility requirements: Because personal loans incur more risk for lenders, qualification standards are often higher for borrowers applying for personal loans. This dynamic reflects the lender’s preference to work with borrowers with stronger credit histories who are less likely to default on the loan.
When To Take Personal Loans For Home Improvements
Personal loans can be more suitable during urgent situations than home equity loans, HELOCs, or refinancing because you receive the necessary funding faster. For example, you discover that your roof is leaking, and immediate repairs are necessary to prevent further damage to your home's interior. Waiting months to hear back about your application for a home equity loan or HELOC will lead to more extensive and costly damage. As a result, getting a personal loan within a week can help you minimize the damage.
Another scenario for a personal loan is when you want to sell your home soon and have identified specific renovations that can significantly increase its market value. These improvements, such as kitchen upgrades or adding a bathroom, will lead to a higher sale price and possibly attract more buyers. Plus, you want to move within a few months, so waiting to qualify for another loan type isn't feasible. A personal loan application has a quick turnaround time and will lead to a higher return on investment when selling your home.
Alternatives To Home Improvement Personal Loans
If you can wait longer for financing to come through or don’t have a high enough credit score to qualify for a personal loan, alternatives to personal loans are available. Here are the details on some other options:
A cash-out refinance lets you replace your original mortgage with a new one and liquidate your equity. Remember, you’re getting a new mortgage with terms and rates replacing the original. Depending on market conditions, that might mean taking on a higher interest rate.
Qualifying for a cash-out refi is similar to getting your original mortgage. Borrowers usually need a credit score of 620 and a DTI of 50% or less. Plus, you’ll need at least 20% equity in your home. Lastly, you can pay the closing costs upfront or roll them into your new mortgage, although doing so will raise your loan balance and likely lower how much cash back you receive.
A credit card is convenient for paying for less expensive home repairs. A credit card provides instant purchasing power if you have one (otherwise, applying for and receiving a card could take a few weeks). Plus, you can earn cash back if you have a rewards card, lowering the overall cost of the project. For instance, 2% cash back on a $5,000 project equals $100 in your pocket.
Remember, you’ll have about a month to pay the balance before it starts incurring interest. If you can’t afford to pay, financing with a credit card isn’t feasible because interest rates are usually at least 20%. Additionally, because the average credit card holder has a credit limit of around $22,000, other financing tools are necessary to afford more expensive projects (such as remodeling a kitchen).
Home Equity Lines Of Credit (HELOC)
A HELOC turns your equity into an account you can borrow against for 5 – 10 years before repaying the balance. For instance, if you have $100,000 in home equity, a HELOC allows you to treat that balance like a credit card with an extraordinarily high spending limit (in most cases, up to 80% of the value of your home).
This tool lets you perform renovations over several years without the pressure of immediately repaying the balance. You’ll only owe interest during the draw period, which is tax-deductible when you use the funds for home improvements.
After the draw period, you’ll have ten to twenty years to repay the principal. HELOCs can have variable interest rates, which can raise your monthly payments. Plus, because they provide a line of credit instead of a lump sum, they’re less suitable for one-off projects.
Home Equity Loans
These loans provide a lump sum of money with a fixed interest rate, making them predictable and stable for budgeting purposes. This makes them particularly advantageous for significant renovation projects where a substantial amount of funding is required. Additionally, the interest paid on home equity loans may be tax-deductible, further enhancing their appeal.
This debt becomes a second mortgage, sitting alongside your original mortgage. As a result, you'll owe two monthly payments for your house.
Remember, lenders assess your home's current market value when providing home equity loans and HELOCs. As a result, if the real estate market is down, you may have less equity than you think. On the other hand, a soaring real estate market can provide tens or hundreds of thousands of dollars in equity. Borrowing only what you need is crucial to avoid an underwater mortgage if the housing market suffers.
The Bottom Line
A personal loan for home improvement projects is a versatile and accessible financing option for homeowners seeking to renovate, repair, or upgrade their homes. Personal loans offer quick access to funds and don't require collateral, allowing for swift action when improving your home.
Remember, it's advisable to be mindful of how the higher interest rates and shorter repayment terms impact your budget. The costs of a personal loan depend on your credit score instead of your home equity, so improving your credit before applying is crucial. Ultimately, the choice of financing depends on individual circumstances, the scale of the project, and the homeowner's long-term financial goals. If you’re ready to get the ball rolling on your home improvement project, apply for a personal loan today.