Types Of Home Improvement Loans

How do home improvement loans work?

Home improvement loans are typically offered by banks, credit unions, and online lenders making them readily accessible to most consumers and fairly easy to apply and qualify for.

In addition, personal loans can have much lower interest rates than credit cards, although rates may be higher than using other forms of financing like a home equity loan or line of credit which uses your home's equity as collateral to secure the loan.

We'll cover the pros and cons of other financing options in the section below.

What types of loans are available for home improvements?

There are several different types of financing that homeowners can use to get the funds needed to fix up their home or other property. We'll cover the basics of some of the most popular alternatives to home improvement personal loans below:

Cash-out refinance pros and cons:

A cash-out refinance uses your home's equity to provide you with funds that can be used towards home improvement projects and other expenses. These loans allow you to refinance your home with a new mortgage while taking out some of your home's equity in cash. They can be a great way to obtain the cash you need without taking out a separate loan with its own monthly payment. However, there are a few disadvantages to completing a cash-out refinance. You will end up paying more in interest on your mortgage and increasing your monthly payment since you are increasing the loan amount, and you will also need to pay for closing costs. You will likely need to undergo an appraisal and may need to pay private mortgage insurance if you withdraw more than 80% of your home's total equity. It will also take a long time to pay the cost of your home improvements off. Lastly, like other equity-based financing options, a failure to repay your loan means that you are subject to foreclosure.

Home equity loan pros and cons:

Home equity loans use the equity that you have built up in your home to secure the loan by placing your property as collateral. Taking out a secured loan means that in the event of a failure to repay the loan, the lender can seize the asset, in this case your home. This makes home equity loans a potentially risky form of financing. However, on the plus side, home equity loans have significantly lower interest rates and can have much longer repayment periods than personal loans, making them more affordable to repay. Home equity loans can be stretched out with loan terms up to 30 years, resulting in very low monthly payments over the lifetime of the loan.

FHA 203(k) rehab loan pros and cons:

FHA 203(k) rehab loans are another great option for many homeowners. They offer the ability to combine your home improvement financing and your home's mortgage together in the same loan. You can also obtain an FHA 203(k) loan by refinancing your home. Interest rates are also extremely competitive when compared to other types of home improvement financing. However, the cons of FHA 203(k) loans include a tedious amount of paperwork and red tape, restrictions on how the funds can be used, and the need to complete the work with a licensed contractor and in a short period of time. All repairs must be eligible and are subject to approval by an FHA appraiser and potentially even a HUD consultant before the work can begin. In addition, borrowers will need to pay closing costs and mortgage insurance, expenses that are not associated with taking out a personal loan, although some personal loans may require an origination fee. You will need to weigh the pros and cons of an FHA 203(k) loan to your own unique financial situation. For example, if you would need to refinance in order to take advantage of the FHA 203(k) loan, a personal loan may be a better option, but if you are buying a fixer upper, an FHA 203(k) loan may be exactly what you need.

HELOC (home equity line of credit) pros and cons:

Similar to a home equity loan, a home equity line of credit uses the equity in your home to allow lenders to approve you for financing. Since this type of financing uses your home as collateral, interest rates may be lower than unsecured forms of financing such as home improvement personal loans. With a HELOC, you will have access to funds via an open line of credit that allows you to repay and withdraw funds as many times as you need during the draw period (up to your credit limit of course). After the draw period has ended, your HELOC will typically enter into a repayment period while you pay off the remaining balance. For this reason, a home equity line of credit is a great option for homeowners looking for flexibility and easy repayment over a longer period of time. However, a HELOC does carry the risk of losing your home since you are using your home's equity to secure the financing. In addition, HELOC interest rates are typically higher than FHA 203(k) loans and usually come with a variable rate which can make repayment unpredictable and costly.

Personal loan pros and cons

There are many advantages of using personal loans to finance major life expenses such as your home improvement projects.

PROS:

Fixed monthly payments. Personal loans are a form of installment loan, which means they are very predictable and easy to repay. In most cases, personal loans have fixed interest rates so the monthly payment does not fluctuate.

Competitive interest rates. Interest rates are competitive, especially when compared to using credit cards, and fees are typically minimal.

Easy to apply for. Personal loans should be relatively easy to apply and qualify for.

Fast funding times. Personal loans usually fund faster than secured loans. Some lenders can fund personal loans in as little as one business day.

No spending restrictions. Personal loans also do not come with any restrictions as to how the funds should be used, in contrast to a financing option like an FHA 203(k) loan which comes with a whole host of restrictions and is subject to approval.

No collateral required. In most cases, personal loans are approved based on the creditworthiness of the borrower. You should not have to provide collateral to obtain a personal loan.

While there are many pros to using a personal loan, there are cons too.

CONS:

Higher interest rates than secured loans. Personal loans may have higher interest rates and shorter repayment terms compared to secured loan options such as a home equity loan.

Credit is important to qualify. Since they are usually unsecured, if you have poor credit you may not be able to qualify or may be subject to a much higher interest rate or origination fee.

Taking on debt. Any time you take out a loan, you are increasing your debt. Debt can impact your credit score, especially if you have too much of it.

These are all of the things to keep in mind when you are selecting a home improvement financing option that works for you.

Should I get a personal loan for home improvements?

Although the answer to this question will depend on your own personal financial situation and unique needs, when compared to the other financing options detailed in this article, personal loans often come out ahead for many reasons. Due to the advantages listed above, you may want to consider taking out a personal loan for your home improvement projects.

Credit cards pros and cons

In some circumstances, credit cards can be a valuable financial piece. If you properly manage credit cards, you can reap the benefits. However, using credit cards for purchases or projects that you will need some time to repay may not be the best idea.

PROS:

Rewards. Credit cards can offer lucrative rewards. Therefore, it may be wise to use them for daily spending, but pay them off right away.

Promotional offers. You may be able to find credit cards with promotional 0% interest periods. If you can repay the principal within the promotional period, this can be a smart way to borrow money at zero cost to you.

CONS:

Interest. Interest can be extremely high for credit cards. You will want to pay off your principal each month to avoid a running balance that is accumulating hefty interest charges.

Smaller borrowing limits. Credit cards typically have smaller limits than taking out a loan, so if you need a large amount of money, credit cards may not cut it.

When to use a credit card for home improvements

If you only need to finance a few thousand dollars or you need access to an ongoing source of funds without using your home as collateral, then credit cards may still be the best option for you. You should be able to pay off the principal within 30 days. If you need several months to afford a project or purchase, you should look into other options.

What type of loan is best for home improvements?

There are many different types of loans for home improvements, including home equity loans, personal loans, and FHA 203(k) loans. The type of loan that you select will depend on your own personal financial situation and home improvement plans. You will need to evaluate your needs and your eligibility to see what type of loan is available to you. For example, if you do not have enough equity in your home, it will limit your options to unsecured personal loans and FHA 203(k) loans.

What type of loan should I get for home improvements?

The type of loan that is best for home improvements is the one that makes the most financial sense for you. In many cases, a personal loan comes out ahead when looking at the different factors such as interest rate, risk to the borrower, and flexibility. However, you will need to do some research and compare the different loan options available to you before applying. You can even get prequalified to get a better idea of the rates and loan terms you can expect to qualify for once you submit your loan application.

What are renovation loans?

The term "renovation loan" typically refers to a mortgage such as an FHA 203(k) loan which rolls up the costs of necessary home repairs into the mortgage itself. In addition to the FHA 203(k) loan, there are a few other lesser known options such as the Fannie Mae HomeStyle® Loan or the USDA Rural Development Home Repair Loan. All of these loans allow homeowners to take advantage of one combined monthly payment that covers the cost of both the property and any renovations being done to it.

In some cases, "renovation loan" may also be used in reference to a home improvement personal loan which gives borrowers quick access to large amounts of funding that can be used towards renovation projects, no matter where they are in the homebuying process.

What is the best home improvement loan?

The best home improvement loan is the one that allows you to complete the work you need with the most affordable financing, so you do not pay unnecessary taxes, interest, or fees.

If you decide to take out a home improvement personal loan, some of the best lenders to borrow money from include online financial institutions like LightStream and SoFi who allow qualified applicants quick access to cash with loan amounts as high as $100,000 with very competitive interest rates and no origination fees.

Can you get a home improvement loan with home equity?

If you are seeking a financing option that uses your home's equity as collateral, there are a few different financing options that you can take advantage of to fund your home improvement projects. Homeowners with at least 15-20% equity in their property can seek out either a home equity loan or a home equity line of credit to meet their financing needs. Just be sure to properly repay your HELOC or home equity loan, or you may be subject to foreclosure.

Can you get a home improvement loan when buying a fixer upper?

You can get a home improvement personal loan at any time before, during, or after the homebuying process, although it is typically recommended to get a personal loan or any other type of financing after the origination of your mortgage, so you don't risk losing your financing.

Another popular option to finance your home improvement projects while buying a fixer upper is to take out an FHA 203(k) loan. These mortgages allow you to roll up the costs of the home repairs into the same loan, allowing you to finance both the renovations and the property at the same time with one monthly payment.

What credit score is needed for a home improvement loan?

To get a home improvement personal loan with the best rates, most lenders want you to have a credit score of at least 660 or above. However, there are many lenders, such as Prosper, Upgrade, Best Egg, OneMain Financial, and LendingPoint who allow borrowers to take out personal loans with credit scores as low as 600. In fact, Upgrade even originates personal loans for borrowers with credit scores as low as 560.

However, it will be to your benefit to improve your credit score as much as possible before applying for a personal loan or use a co borrower to avoid paying unnecessary interest and fees.

What is the average interest rate on a home improvement loan?

As of March 2022, the average interest rate on a personal loan is just under 11% for borrowers with prime credit scores. Since home improvement loans are a type of personal loan, you can expect to see interest rates in this range.

On the other hand, if you take out a home equity loan you can expect rates in the ballpark of 6% and FHA 203(k) rates are currently sitting around 3-4%.

Is a home improvement loan tax deductible?

Depending on what type of home improvement loan you select, the interest paid on your loan may be tax deductible.

The interest paid on personal loans is usually not tax deductible unless you are using the loan for business expenses, qualified higher education expenses, or taxable investments.

With an FHA 203k loan, since it is structured as a mortgage, the interest you pay on your loan is tax deductible. This may make the FHA 203k loan a more attractive option for your financing.

Likewise, the interest on a home equity loan that is used for renovations is tax deductible as long as the repairs are being made to the same property that has been placed as collateral.

How do you determine your home improvement loan needs?

You will need to take a look at your own personal financial situation in order to evaluate the available options and determine which type of home improvement loan is best for you.

You will need to ask yourself questions such as: Do I have any equity in my home? Do I have good enough credit to qualify for a good interest rate on a personal loan? Do I want to include the cost of my home repairs into my mortgage? Do I mind taking on the risk of using my home as collateral? How much money do I need to borrow? What type of financing does my current bank offer? Do I want the interest paid on my chosen financing to be tax deductible? Am I ok with getting all of my renovations approved beforehand or do I prefer quick access to cash? Am I hiring a licensed contractor or am I hoping to complete my home repairs myself?

Asking these questions will help you determine your home improvement loan needs and make an educated financing choice.

How do you compare home improvement lenders?

The best way to compare home improvement lenders is to do some brief research online, and then consider getting prequalified with a few different lenders to see which one can offer you the best interest rates and other loan terms. Once you have a better idea of which financial institution can offer you the best deal, you can complete the official loan application with the lender of your choice. In general, credit unions and online lenders will have better rates and more flexible loan terms than traditional banks. So keep that in mind when shopping around.

How do you apply for a home improvement loan?

Most lenders offer an online application process. If you are pursuing a home improvement loan, you should start by checking offers. At Acorn Finance, you can check offers from top national lenders with no impact on your credit score. Within 60 seconds or less you can receive offers. Online lenders may be more competitive since they know they are competing side-by-side with other legitimate lenders.