UPDATED: Feb 4, 2024
For many homeowners, the desire to take on a home improvement project is only natural: They live in a place for a while, then they start to consider ideas like, “What if we expanded the living room?” or “An enclosed deck would be nice, wouldn’t it?” Or maybe they see some of the latest home improvement trends and they want to give them a try.
This is all part of the fun of owning a home, but there’s one problem: paying for the construction work. That’s where taking out a home improvement loan comes in.
A home improvement loan provides the financing that allows homeowners to get construction or renovation work done on their home. These loans are short term, typically a year, and they come with interest rates that are higher than a traditional mortgage. These loans are specifically intended to cover costs related to repairs, remodeling and other property enhancements.
But it’s important to have guardrails in place. When you’re starting a home renovation project, one of the most important items to address upfront is your budget. Without a budget, homeowners can easily underestimate their renovation costs or spend more than they intend to. Putting a smart and feasible budget in place before you begin can save you money – as well as headaches in the future.
In addition to creating a more comfortable and attractive home, there are several reasons you may want to take out a home improvement loan, including:
Increasing home value: It only stands to reason that improving your home raises its value. Enhancements that can increase your value include sprucing up the exterior (you may recoup 91% of the cost of updating your home with manufactured stone veneer, according to Remodeling Magazine’s Cost vs. Value report). Creating a more attractive landscape around your home will also impress potential buyers down the road, and an updated kitchen is always a plus.
Remodeling versus moving out: While remodeling a house can be expensive, don’t forget that selling an old home, buying a new one and moving are all costly steps, as well. In addition to prepping your home to sell, you must pay real estate agent commissions, sales and transfer taxes, closing costs on the home you buy – and moving costs can be pricey, as well. Plus, when you renovate, you can pick and choose which projects you want to take on, which gives you more control over the money you’ll spend.
Conducting an emergency repair: Say your roof starts leaking, your furnace breaks or you develop plumbing problems. Using a home improvement loan for emergency repairs allows you to swiftly address the issue, prevent further damage and ensure the well-being of your property. This loan can be especially useful when you don't have the savings available to cover the cost of the repair, making the loan a practical financial tool in times of unexpected crises.
When you take out a home improvement loan, you typically get a lump sum of money that you can use to make improvements to your home. The loan amount and terms, such as interest rate and repayment period, are determined by factors like your credit history, income and the value of your property.
There are several different types of home improvement loans, including:
A personal home improvement loan provides funds for renovating, repairing or upgrading your residence. In this type of loan, you get a lump sum that you can repay in installments over a fixed period. Lender considerations include higher interest costs and criteria based on creditworthiness, making it best for individuals with good credit who are seeking to make moderate home improvements without using their property as collateral.
An FHA rehab loan – also known as a 203(k) loan – is a government-backed program designed to help homeowners finance the purchase of a home as well as the cost of repairs or renovations. This loan works by combining the home's purchase price and the estimated renovation expenses into a single loan. These are typically accessible to borrowers with lower credit scores and offer more lenient credit and income requirements.
This loan program enables home buyers to finance the purchase of a home – in addition to the cost of renovations or repairs – via a single mortgage. It also allows borrowers to borrow up to a certain percentage of the property's after-improved value, providing the convenience of financing both the acquisition and improvements through a single loan. HomeStyle loans often have slightly stricter credit requirements compared to FHA rehab loans, and they usually require a higher down payment.
There are also alternatives to home improvement loans that may be a better choice for some homeowners. They include:
This option allows homeowners to borrow money against the equity they have built up in their homes by taking out a new mortgage that is larger than their current mortgage balance. The existing first mortgage is then paid, and the difference between the two loans is given to the homeowner in cash.
You can refinance and withdraw some of your equity – sometimes as much as 80% – as cash. So, if you have $60,000 worth of equity, you might be able to withdraw about $48,000 to use for renovations.
This popular type of loan is a type of second mortgage that allows homeowners to borrow against the equity in their home. Using the house as collateral to secure the loan lowers the risk for lenders, and that lower risk often translates into lower interest rates than other financing options (but higher rates than a cash-out refinance).
A home equity line of credit (HELOC) works like a credit card that’s tied to your home’s equity, allowing you to borrow against the value of your property. It essentially provides you with funds that you can borrow and repay multiple times within a set period.
Obtaining a home improvement loan requires a fair amount of preparation and legwork, but it can be well worth it in the long run. Here are some of the elements that lenders typically require to get a home improvement loan.
To be approved for a home improvement loan, borrowers typically need to meet specific criteria:
A credit score with a minimum of 680 is typically required to demonstrate a history of responsible credit management.
Additionally, a low debt-to-income ratio (DTI) is critical – often with a ratio below 45% – which will ensure that borrowers have enough income to cover their loan payments.
Obtaining a loan for your home improvement project can be easier if you have good credit, but homeowners who have less-than-stellar credit can also get loans. Here are some of the steps that can help:
There are several different types of home improvement loans, and they’re not one-size-fits-all offerings. By doing your homework and examining your options, you can find possibilities that will work for you, your pocketbook – and your property.
A construction loan can provide the funds to build a new home or finance a remodel of your existing home.
If you’re a current homeowner and ready to use the equity built in your home, consider a personal loan with Rocket Loans℠ to help you create the home of your dreams.
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