Key takeaways
Home improvement loans are used specifically for financing repairs, renovations or remodels.
Lenders offer unsecured loans based on your credit or secured loans based on your property's equity.
Comparing lenders is the most reliable way to find the lowest rates for the type of renovation loan you choose.
A home improvement loan can be a good option for financing necessary repairs, renovations and even remodels. Also called renovation loans, there are five options to choose from. You will need to research lenders and determine if a home improvement loan is a good idea for your project.
There are five types of home improvement loan you can consider when beginning your renovation loan search. While each option will give you the funds needed to finish your project, some may work better than others.
Good for borrowers with a good amount of home equity. This is ideal for those that have more worth in their homes than what is owed on the mortgage.
Funded by the equity in your home and received in a lump sum, a home equity loan usually has a fixed interest rate repaid between five and 30 years. Lenders generally allow you to borrow up to 85 percent of your home’s equity for the project.
You can apply for a home equity loan through banks, credit unions or online lenders. Interest rates and overall terms offered depend on your creditworthiness.
One of the main advantages of using a home equity loan is you typically get lower interest rates than with other types of financing, since the loan is secured by your home. You can also write off the interest at tax time, since it’s deductible if the funds are all used for home improvement.
A major drawback is that defaulting on the loan could come with some serious consequences, including foreclosure.
Good for borrowers with some equity and an ongoing project. HELOCs boast some of the lowest interest rates available, making them a great option to keep your monthly payment low while your improvements are being made.
A HELOC is another way to finance home renovations using your home’s equity. Unlike a home equity loan, a HELOC works more like a credit card. It allows borrowers to withdraw funds as the need arises for a set period with fixed or variable interest rates.
HELOCs are an excellent way to fund ongoing home projects since you don’t have to use all of the credit at once. You can continue to draw from the line of credit as you need until the draw period closes, which is typically after 10 years.
When comparing HELOC options, watch out for ongoing fees and penalties for closing out your credit line early. Like home equity loans, HELOCs also use your home as collateral, so you put your home at risk if you can’t repay the loan. You also get the same tax-deduction perk if you use your HELOC specifically to pay for home improvement expenses.
Good for borrowers with a small or midsize project. You can finance a small or midsize home project with an unsecured personal loan. They can be a good option for emergency home repairs as well since personal loans tend to offer quick funding, sometimes as soon as the day after you apply.
A personal loan is similar to a home equity loan because you receive all of the funds at once and make payments at a fixed rate. However, personal loans are typically unsecured, which means you don’t risk your home if you default. They’re a good alternative to home equity loans or HELOCs if you don’t have enough equity to cover the cost of your renovation plans.
Personal loans are offered by a variety of different lenders. Terms usually range from two to seven years, and rates will generally be between around 7 percent and 36 percent.
Personal loan rates are usually higher than home equity products, although excellent credit borrowers may get rates comparable to home equity loans. Because a personal loan for home improvement is funded as a lump sum, you have less flexibility than with a credit card or personal line of credit and may need to borrow more if your project costs exceed your budget.
Good for a low payment on a big renovation. If you have a major home upgrade in the future, cash-out refinance can spread the payment out as long as thirty years to keep your monthly payment lower than most other options.
To qualify for cash-out refinancing, you apply for a new mortgage on your home for more than you owe and pocket the extra money which you can use for home improvements. You get the cash as long as you have “extra” equity in your home.
Similar to home equity loans, you receive all of the funds at once and typically choose a fixed rate with a repayment term as long as 30 years. However, you usually can’t borrow more than 80 percent of the value of your home.
That said, a cash-out refinance may not make sense as a renovation loan if you have an interest rate that’s lower than current mortgage rates. You may also pay higher closing costs since your loan amount is typically much higher that what you’d borrow with a home equity loan or personal loan.
Good for buying and renovating your house in one go. An FHA 203(k) rehab loan can make both the purchase and renovation of your home possible, especially if you have less-than-perfect credit.
Supported by the Federal Housing Administration, an FHA 203(k) rehab loan is a financing option that combines both the cost to purchase the home and the cost to remodel or repair it. This single loan essentially does the job of two: it’s a mortgage and a home improvement loan.
Rates are based on your creditworthiness and income, and terms will vary between a 15- or 30-year fixed-rate mortgage or an adjustable-rate mortgage (ARM). Borrowers with poor credit can often qualify for these loans since FHA credit score standards are more lenient than other home equity options.
When you apply, you will have two options. The limited 203(k) loan is meant for projects valued at less than $35,000 and has a simpler application process. The standard 203(k) loan has a more involved application but allows you to finance projects larger than $35,000.
Best for larger purchase and renovation combinations. A conventional mortgage renovation loan is ideal if you need a larger loan amount than FHA loan limits allow or want to make some luxury upgrades to your home that the FHA doesn’t permit.
Fannie Mae and Freddie Mac provide funding for conventional mortgages and set the guidelines for renovation loan programs similar to the FHA 203(k) program. The most popular program is the HomeStyle Renovation program offered by Fannie Mae lenders.
You can roll the cost of your improvements into one loan. An added benefit is the loan is based on an estimate of how much your home will be worth after you improve it, rather than its current value. You can also access higher loan amounts with fewer restrictions on the types of renovations than you find with the FHA 203(k) program.
Just as you would approach any product, consider the following factors when shopping for a home improvement loan.
Approval criteria. Each lender has its own requirements for a borrower’s credit history, debt-to-income ratio and income. Consider approval requirements before applying for a loan.
Fees. When comparing potential rates, look at any fees that may be incurred during the application or throughout the life of the loan since these will also add to the overall cost of borrowing.
Loan amounts. Depending on the scope of your project, the size of your loan matters. Do the math ahead of time to ensure you finance enough money to complete your home improvement.
Repayment terms. The longer your repayment term is, the less expensive your monthly payment will be. However, you’ll pay less interest if you choose a shorter term. Weigh both options when shopping for a lender.
Do your research to determine which loan option is best for the size and scope of the renovations you have planned. From there, consider at least three lenders to find one with the most competitive terms. As long as you approach finding a home improvement loan with care and diligence, you can bring your blueprints to life — with or without perfect credit.