Upgrading the bedroom or planning for a new kitchen, renovating can be a wise option. To be honest, it actually increases the home’s value for resale.
Keeping that in mind, I did a lot of legwork and brought you 6 types of home improvement loans. From understanding what a home improvement loan is to which one you can rely on, I have tried covering almost everything.
In addition, I have also tried listing a quick checklist to understand if you are really in need of getting financial help for home remodeling.
So, let’s start with the definition of a home improvement loan.
Finding Remodeling Loans with a Lower Interest Rate
Homeowners who have equity on their houses can use home equity loans or HELOCs (home equity lines of credit). You can extensively finance your home improvement projects with these loans as the interest rates are lower than on credit cards or personal loans.
No matter how much we try to list the expenses during renovating the home, there is always some amount that we usually forget or are completely unaware of. So, choosing HELOC seems easier if you do not know what exact amount you will need. However, if the floating interest rates concern you, try the other options mentioned below.
But, before everything, let’s understand how a home improvement loan functions. Is there a basic fundamental that is carried out everywhere? Let’s check out.
How Does A Home Improvement Loan Work?
When you secure a personal home renovation loan, your creditor will provide you a lump-sum amount. The reimbursement process starts as soon as the loan is granted. You’ll have to repay the loan in fixed monthly payments. The interest is calculated on the entire loan amount. This interest differs; it is based on your creditor and creditworthiness.
Some lenders also impose origination fees, which generally vary from 1% to 8% of the loan balance. On the other hand, a few contracts are free of cost. You can use your savings to pay for home improvements like improving your electrical system or remodeling your kitchen.
As per my theories, do not consider these loans like credit cards. You can reuse credit cards up to a specific limit after repayment, but that’s not the case in home improvement loan. If you need more finance after using up the funds, you’ll need to apply for another loan for home renovations. However, you should be cautious about taking out a second loan because another strict inquiry can harm your credit.
Home improvement loan refers to a variety of financial instruments. There are three popular choices for home renovation. They are home equity lines of credit, home equity loans, and personal loans (secured and unsecured). Although each of these loans has its own unique features, they all have one common factor.
You may ask me what it is. Here is what I have found. If you meet the criteria for financing, a lender will grant you funds for your home repair project. And, in return, you’ll pay back the money you acquired, plus interest and additional fees.
Once you’ve decided to take a loan for home renovations, you can turn to various lenders for assistance. This includes credit unions, banks and online lenders.
Many home improvement loans are passed on to the three credit reporting agencies. If you want to maintain your credit scores, you must constantly make timely payments. And, of course, this can help them too.
Do I Need To Finance My Home Remodeling?
Your financial status and the size of the work will determine how you repay for your home improvement. The best way to make the payment for a home upgrade is to retain a specific project and then use those funds. This isn’t always doable, though. That is because you may require financing for unexpected bills or some major renovations.
So, consider your monthly budget for deciding whether home renovation financing is right for you. Also, don’t forget the size and return on investment of your project . I would say, ask these questions:
- Is it possible for you to make an additional monthly payment?
- Is the project you’re planning to work on going to add value to your home?
- How long will it take to complete this remodel?
Which Home Improvement Loan Is Right For Me?
Here is a quick look at the different home improvement loan options:
Home equity loan
A home equity loan (HEL) gives you the benefit of borrowing against the value of your house’s equity.
How does it work?
Your equity is determined by estimating the value of your house and deducting the outstanding sum on your existing debts. You can pay off your new home equity loan along with your previous mortgage.
The right time to take a home equity loan is:
- when you have much equity on your home
- when you require finances for a large, one-time operation.
This type of home improvement loan is distributed as a single upfront payment. Your home acts as security for a home equity loan. Since the loan is secured against the house, lenders can provide lower rates, similar to a mortgage.
If you need a big sum of money, a home equity loan is a smart alternative because of the low, stable interest rate. You’ll almost certainly be responsible for the loan’s closing charges. Consequently, the amount you’re borrowing must be sufficient to justify the additional expense.
A home equity loan could be tax-deductible. To be sure, consult your CPA or tax advisor.
Pros of Home Equity Loans:
- The interest rates on home equity loans are typically fixed.
- The duration of a loan might range from five to thirty years.
- You can take out a loan for up to 100% of your equity.
- It’s ideal for large-scale activities like renovation.
Cons of Home Equity Loans:
- If you still owe money on the original mortgage, it adds as a second monthly loan payment.
- Origination fees and related closing costs are charged by most credit unions, creditors and banks.
- Since you’ll get the fund in one go, plan your budget for home repair cautiously.
A cash-out refinance is a common way to receive money for home renovations.
How does it work?
You refinance into a new mortgage loan with a higher balance than the one you presently owe. With the new fund, you settle up your previous mortgage and retain the remaining amount with you.
The sum you get from a cash-out refinance stems from the value of your home. You can use it to pay for your home renovations. Yet, there are no regulations for that.
When is it a good idea to get a cash-out to refinance?
If you can restart the loan at a lower interest rate than your current loan, go for a cash-out refinance.
You may also be able to decrease the loan term to compensate for your house faster.
Let’s imagine you still have 20 years left on your 30-year debt. Your cash-out refinance may be a 15-year contract. This means you’d be paying off your house five years sooner.
So, how do you determine if a cash-out refinance is right for you?
Compare the expenses over the tenure of the loan, adding the closing costs. This entails comparing the entire cost of new debt to the cost of maintaining your present loan for the rest of its term.
Don’t forget that cash-out refinances come with increased closing charges. This applies to the whole loan amount and not only the cash-out. Therefore, to make this loan option profitable, you’ll need to discover an interest rate that’s much lower than your present one.
Pros of Cash-out finance:
- Cash-out fund from home equity
- You’d make current mortgage payments at regular intervals
- You can cut your interest rate and stretch your loan term simultaneously.
- You can spend the money on whatever you like.
Cons of Cash-out finance:
- To have the closing costs, you will need a bigger loan amount.
- Your new loan will have a greater amount than your old one.
- Your loan is reset when you refinance it.
Home Equity Line of Credit
A HELOC (Home Equity Line of Credit) is similar to a home equity loan (HEL), but it operates more like a credit card. You can borrow up to a predetermined amount, repay, and borrow again.
Another difference between HELOCs and HEL is that HELOCs have floating interest rates. That means they can increase and decrease throughout the loan duration. However, interest is only charged on the remaining balance of your HELOC. This is the sum you’ve actually drawn and not on the total credit.
When to take a HELOC?
A HELOC may be a better option than a HEL. But, you can pick it if you need to fund a few less pricey or lengthy renovation projects regularly.
Other factors to consider while taking a HELOC are:
- The value of your home, income and your credit score will decide your expenditure limit.
- HELOCs have a fixed loan period, which is typically between 5 and 20 years.
- Your interests rate and credit terms may change during the tenure.
- Closing costs are either low or zero.
You have to pay the loan amount fully at the end of the draw period. If not, the HELOC can turn into an amortizing loan.
It’s worth noting that the lender may be allowed to amend the loan terms over its life. If your credit score falls, for example, this can limit the amount you can borrow.
However, HELOCs still provide flexibility. You don’t have to take money out of your account until you need it. You can use the credit line for up to ten years.
Pros of HELOC:
- Closing costs are minimal or nil.
- The payment changes according to the amount received.
- It’s recurring. You can use the money again after you’ve paid it back.
Cons of HELOC:
- Loan prices are frequently adjustable, which means that your rate and payment may increase.
- Banks and credit unions can alter the repayment conditions.
FHA 203(k) Rehab Loan
An FHA 203(k) rehab loan combines a mortgage and home repair costs into one. You won’t have to apply for two distinct loans or incur closing costs twice if you use an FHA 203(k). Instead, when you purchase a house, you can fund your home buying and renovations cost simultaneously.
When you’re getting a fixer-upper and realize you’ll need money for home improvements soon, FHA 203(k) rehab loans are reliable. And because the government funds these loans, you’ll get special privileges. This includes reduced down payment and the opportunity to apply even if your credit isn’t ideal.
Pros of FHA 203(k) rehab loan:
- Presently, FHA mortgage rates are at an all-time low.
- Your security deposit can be as minimum as 3.5 %.
- Most lenders demand a credit score of 620 or higher (some may go even lower).
- You don’t have to be a first-time purchaser to apply.
Cons of FHA 203(k) rehab loan:
- Only suitable for elderly or fixer-upper homes.
- FHA loans involve upfront and monthly mortgage payments
- Remodeling costs must be at a minimum of $5000.
- The usage of funding under the 203k program is limited to particular home repair projects.
An unsecured loan is another option for financing home repairs if you don’t have a lot of equity.
These loans are easier to obtain than HELOCs.
Personal loans can have variable or fixed rates. But, they usually have a higher rate than a home equity loan or a home equity line of credit.
However, if you have excellent credit scores, you ought to secure a reasonable rate.
A personal loan’s repayment period is less adaptable. That is to say, it’s usually two to five years.
You’ll need to pay the closing charges as well.
The terms may not appear to be very appealing. However, for some people, personal loans are far more approachable than HELOCs or home equity loans.
A personal loan might be a fantastic option to choose for home repairs. That’s an option when you don’t have sufficient equity in your property to borrow against it.
These loans are beneficial for financing emergency home repairs. For instance, you can use them when your water heater or HVAC system needs to be updated instantly.
Pros of Personal Loans:
- The application process is fast.
- Funds are available preferably on the same working day.
- There’s no need to put a lien on your house.
- It’s ideal for last-minute repairs.
Cons of Personal Loans:
- Your creditworthiness influences loan rates.
- Limited borrowing limits
- Shorter loan payback terms
- Prepayment penalties apply in some cases.
- Late penalties on loans are pretty excessive.
You might also use a credit card to pay for any or all of your remodeling expenses. For your home repair project, this is the fastest and easiest financing choice. You won’t even require to fill up a loan application form.
However, because home improvements might cost thousands of dollars, you’ll need a hefty credit limit to get accepted. You’ll either have to use two or more credit cards.
In addition, most credit cards charge high-interest rates.
When should you use credit cards for home renovation?
If you want to use a credit card to pay for your renovations, look for one with a 0% initial fee.
Some credit cards allow you to pay off your bill in up upto 18 months. This strategy is only viable if you can refinance within that time frame.
Credit cards, similar to personal loans, may be acceptable in an emergency. However, you should not use them for long-term funding.
Even if you have to utilize credit cards as a temporary solution, you may repay the amount with a secured loan afterward.
Pros of Credit Card:
- Fast and easy
- Zero paperwork
- Availability of interest-free choices.
Cons of Credit Card:
- Interest rates are substantially higher than those charged by other financing options.
- The limitations on credit cards are frequently lesser for home improvement budgets.
Tips for Comparing Home Improvement Loans
Here are a few tips that I have gathered while you are comparing these home improvement loans.
- Decide how much funds you need. Different home renovation loans feature different lending limits. Analyze your project and determine how much it will cost before applying for credit. With the information, compare the loan types that will help you get an adequate amount.
- Prequalify wherever possible. Many personal loan lenders allow potential borrowers to prequalify for a loan using simply a credit inspection. Let me tell you that this does not affect your credit score.
With this, you can submit your house condition, income, and financial requirements. Once done, the lender will calculate and let you know what repayment terms, charges and loan sums are you eligible for.
- Stay updated for additional expenses. Fee-free home repair loans are available from some lenders. It allows borrowers to avoid prepayment penalties. Plus, you can even dodge late fees, origination fees, and other standard loan expenses. You have to inquire about the costs when looking for the ideal loan parameters.
- Consider the lender’s customer service offerings. While customer service may not seem important during the initial phase of your loan, it is essential if you have to face payment troubles.
You will also need them if you come across any financial difficulties throughout the payback period. To ensure it’s a good fit, look over the lender’s customer support sources. Gain feedback from its past and present borrowers.
What type of loan is best for home improvements?
Your finances will decide the best home improvement loan for you. If you have a bunch of equity in your home, HELOC or HEL is a perfect match. If you can cut your interest rate or reduce your current loan tenure, you can use a cash-out refinance to pay for home repairs. And, if you don’t have either of them, personal home loans and credit cards will work.
Should I get a personal loan for home improvements?
It totally depends on you. Before taking out a personal loan for your home renovations, consider refinancing or taking a home equity loan. It is because personal loans usually have higher interest rates. However, if you don’t have much equity to borrow, a personal loan for home improvements will be a good idea.
What credit score should I have for a home improvement loan
The type of loan will decide the credit score cutoff for a home improvement loan.
A 620 credit score or greater is required for an FHA 203(k) rehab loan. A credit score of at least 620 is usually required for cash-out refinancing. You’ll need a FICO score of 660-700 or above to use a HELOC or home equity loan.
It’s always safe to try for a score in the low- to mid-700s to apply for a personal loan.
Having a good credit score can assist you in having low-interest rates.
What is the average interest rate on a home improvement loan?
Interest rates vary on the type of home renovation loan you take. Your interest rate will most likely be similar to today’s low mortgage rates whether you use a cash-out refinance or an FHA 203(k) loan.
Other types of home renovation loans, such as home equity loans and HELOCs, have greater interest rates than mortgages. Furthermore, because the HELOC rates are dynamic, they might climb and fall throughout the loan duration.
Which is the best renovation loan?
The FHA 203(k) loan may be the optimal renovation credit if you’re acquiring a fixer-upper or restoring an older property. The 203(k) rehab loan combines your home purchase and restoration costs into a single loan. Thus, it saves you money on interest rates and closing costs.
A cash-out refinance is perhaps the best remodeling loan if your house is newer or has a higher value. This allows you to access the equity in your present property while also allowing you to refinance into a reduced mortgage rate.
Is a home improvement loan tax deductible?
Home improvement loans usually are not tax-deductible. Sometimes, your loan expenses may be tax-deductible if you fund it with a refinance or home equity loan.
I have tried to collate as much information as possible in this blog. However, the cost for renovating a home majorly depends upon how big the area is to renovate and the location of your house.
Before deciding on any loan, I would ask you to consider the smallest expenditure while renovating the home. When I applied for a loan, I shopped through different financial institutions. That helped me understand different terminologies and pick the best one.