Home Improvement Loans: A Complete Guide To Financing Renovations

Have you finally found your dream home, but it’s in desperate need of updating or repairs? Or do you need to add some square footage to your existing home to meet the needs of your growing family? Home improvement loans are one financing option if you don’t have the cash on hand to pay for renovations.

In this article we’ll go over home improvement loans, how they work and which type may best suit your needs.

What Are Home Improvement Loans?

A home improvement loan, also called a home renovation loan, is money that you borrow from a lender to finance costly home improvement projects, such as upgrades or repairs. You can take out a home improvement loan to replace your roof, build an addition, replace outdated home systems (like older plumbing and electrical) or repair weather-related damage. While its name suggests there are restrictions on how you can use the funds, most home improvement loans allow you to use the money for almost anything.

How Do Home Improvement Loans Work?

Similar to a traditional mortgage, a home improvement loan involves borrowing a set sum of money and repaying the lender in monthly installments. Many home improvement loans are approved based on your credit score. Meaning, that if you miss payments, it could damage your credit score. There are two types of home improvement loans, secured and unsecured.

A secured loan, such as a home equity line of credit or a cash-out refinance, uses your home as collateral. This means that if you default on the loan payments, the lender can foreclose on your home. An unsecured loan, such as personal loans and credit cards, doesn’t require collateral. Secured loans often have lower interest rates and higher borrowing limits, but an unsecured loan may be the better option if you don’t want to put your home at risk.

Common Types Of Home Improvement Loans

Home improvement loans come in all shapes and sizes. Here are some of the most common.

Personal Loan

A personal loan provides borrowers with a lump sum of money to be paid back to the lender in an agreed upon timeframe. It can be used for various purposes, including home improvements. Personal loans don't require collateral and can have fixed or variable interest rates.

Using a personal loan for home improvements has pros and cons. On the plus side, it offers quick access to funds and flexible repayment terms. Because it’s an unsecured loan, homeowners don't risk losing their property. However, personal loans may have higher interest rates, especially for those with lower credit scores.

Cash-Out Refinance

A cash-out refinance is a type of mortgage refinancing that allows you to borrow money against the equity in your home. You receive a new, larger mortgage, which pays off the old mortgage and you keep the difference to use on home improvement projects.

This option offers some of the lowest interest rates. However, you’ll need to pay closing costs and go through the mortgage process to get the loan. Make sure the amount of costs doesn’t outweigh any savings from lower rates.

Home Equity Loan

A home equity loan is a type of second mortgage that allows you to borrow against the equity in your home. Instead of paying off your existing mortgage with a new loan, like a cash-out refinance, a home equity loan is a separate loan in addition to your mortgage. You can use this cash to fund your projects and make consistent monthly payments over the loan term.

Home equity loans have a lengthy term, typically 10, 20 or 30 years, and interest rates lower than most other types of loans. There are also certain tax advantages. According to the IRS, if a home equity loan or line of credit is secured by your main home or second home to buy, build or substantially improve the residence, the interest you pay on the borrower funds may be deductible. But there are downsides, including having another big loan payment on top of your mortgage, paying closing costs, and if home value declines, you could owe more money on your home than what it's worth.

Home Equity Line Of Credit

A home equity line of credit (HELOC) is another type of second mortgage that lets you borrow against home equity as a line of credit. HELOCs have two separate phases, known as the draw period and the repayment period. You can withdraw money as you make your home improvements and make minimum or interest-only payments on the amount you borrow. Once the draw period ends, you won’t be able to borrow money from your HELOC and must begin making monthly payments that cover the HELOC’s principal and interest.

HELOCs give homeowners more flexibility to borrow money as needed during the draw period. HELOCs also offer lower interest rates and interest is tax-deductible. But similar to home equity loans, there are upfront costs when you take out a HELOC and you risk losing your home. Another downside is that HELOCs come with variable rates. This means that if rates go up, your payments may increase.

Comparing Home Improvement Loans

When shopping for a home improvement loan, look into multiple lenders and loan products in order to determine the best term and loan for your needs. Consider the following when shopping for a home improvement loan:

• Credit requirements: Your credit score will determine your interest rate and whether you qualify for the loan. Typically, lenders require a minimum credit score of 620 to qualify for most home improvement loans, but there may be exceptions, so ask your lender what credit score you’ll need.
• Offered loan amounts: This is the amount of money you agree to borrow. How much you can borrow depends on the lender and the type of loan, but most offer improvement loans as low as $1,000 and as high as $100,000 or more.
• Loan terms: Loan terms refer to the length of time you have to repay the loan. Loan terms and repayments vary by type of home improvement loan and lender.
• Lender fees: Lenders may charge fees when you take out a home improvement loan to cover the cost of processing and underwriting the loan. Origination fees are typically between 0.5% and 1% of the total loan amount.

How To Get A Home Improvement Loan

With decent credit and a solid repayment history, obtaining a home improvement loan for your property is similar to taking out a mortgage loan or applying for a credit card. Here’s the standard process for taking out a home improvement loan.

1. Check your credit report. Check your credit report and see if you meet the lender’s minimum credit score requirements. If your credit score is too low, try working to improve your score before you apply.
2. Determine how much you need. Have contractors give you estimates so you have an idea of how much money you’ll need to borrow to get the project completed.
3. Shop around for different lenders. Look into multiple lenders and compare loan products and terms. This will allow you to find the best home improvement loan for your financial situation.
4. Apply for prequalification. A prequalification estimates how much you can borrow based on financial information provided to the lender. Prequalification can help give you a better understanding of your financial capacity and speed up the loan application process.
5. Submit a full loan application. When you submit your loan application, the lender may require that you supply additional documentation.
6. Wait for approval. Once the lender approves the loan application and you close on the loan, you receive the funds for your home improvements. Depending on the loan, the lender may wire money to your bank account, or if it’s a HELOC, you will have a line of credit to draw from.
7. Start your home improvements. Once you have your money, you can begin your project. However, your first payment may be due as soon as you start your home improvements, depending on the type of loan.

Home Improvement Loan Alternatives

Here are some home improvement loan alternatives to consider.

Government Loans

Several government agencies, such as the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA), offer renovation loans. For instance, an FHA 203(k) rehab loan provides funds for home buyers and owners who want to purchase or refinance a home in need of repairs. You can purchase a home and receive money for repairs with a single loan. Another popular option, if you qualify, is a VA renovation loan, which also includes both funding for the home purchase and certain types of repairs.

Government loans typically have more restrictions than other types of home improvement loans. FHA 203(k) loans typically require loan applicants to use an approved contractor, have a renovation budget and have a specific timeline of when improvements are expected to be made.

Interest-Free Credit Cards

You can use a credit card with a 0% APR introductory period to finance your renovations. This allows you to borrow money for the project and possibly avoid costly interest charges. But make sure you pay back the loan before the promotional period ends, or you could end up paying off a balance with a high interest rate.

Emergency Fund

The Bottom Line

Home improvement loans can be a great financing option, especially if you need to make repairs immediately and don’t have time to save on a monthly basis. Certain loans typically come with lower interest rates and the interest may be tax deductible if you take out a HELOC or home equity loan. Make sure you compare multiple lenders and loan options before making your decision.