Key learning points
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A home improvement loan can provide homeowners with quick financing and flexible repayment options.
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Home improvement loans may have higher rates and fees for borrowers with bad credit.
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These loans can help you build your credit and increase the value of your home, but they also have potential drawbacks, such as high fees and secured options that put your assets at risk.
Home improvement or home renovation loans are a type of loan that allows you to use your borrowed money to finance work in and around the house. You can finance everything from small renovations to basement conversions.
Personal loans are a common type of home improvement loan, but other types, such as home equity loans and cash-out refinancing, offer their own benefits.
Like all loans, home improvement loans have disadvantages. For example, if you don’t have excellent credit, chances are you will be offered high interest rates and fees if approved. Before applying, weigh the pros against the cons to determine if they are right for you.
Advantages and disadvantages of home improvement loans
Home improvement loans are an essential tool for many people who may not be able to build their savings. But even if you can score low rates, they can still be risky if you struggle to keep up with payments or borrow too much.
Positives
- Helps build credit.
- Financing a major project.
- Add value to your home.
- Fixed payments.
Cons
- Possibly high costs.
- Potentially high interest.
- Some loans are secured.
- Negative impact on credit.
Benefits of a home improvement loan
Home improvement loans are an important tool for homeowners who need to make essential or cosmetic changes to their space.
Helps build credit
On-time payments are always a good way to improve your credit score and can make future loans cheaper.
Additionally, depending on the type of home improvement loan you choose, you can build your credit by expanding the number of types of credit accounts you have.
If your only current debt products are credit cards, an installment loan for home improvements can diversify your credit profile. Your credit mix makes up 10 percent of your total FICO credit score, while age and mix make up 20 percent of your VantageScore.
Financing a major project
Some lenders offer up to $100,000 in personal loans. However, this is not a usual maximum amount and not everyone will qualify for such a large loan.
If you have significant equity in your home, you may be able to borrow even more with a home equity line of credit (HELOC) or a home equity loan.
You should only aim for such a large amount if you have the income to afford the monthly payments. Use a personal loan calculator to compare what your payment would be under different loan terms and interest rates.
More information: How much can you borrow with a home improvement loan?
Add value to your home
With a home improvement loan, you can increase the value of your home by taking on a larger project than you could otherwise save for. Additionally, if you plan to sell your home, you can recoup some of your expenses and make your home stand out on the market.
But buyers appreciate some renovations more than others. The home improvements that add the most value include minor kitchen renovations, basement remodels and energy efficient improvements.
Fixed payments
Personal home improvement loans and home equity loans are fixed-rate installment loans, meaning you have to pay a predetermined monthly payment amount.
Installment loans can be the better financing solution for smaller, short-term projects. Multi-phase renovations are better financed with a home equity line of credit.
Disadvantages of a home improvement loan
Home improvement loans are not for everyone. Factors such as fees, high interest rates and hard credit draws can detract from the value of the loan to you and cause financial stress over time.
Possibly high costs
Not every lender charges the same costs. Your loan may have an origination fee deducted from the total amount you receive or added to the amount you borrow.
Some lenders may also charge late fees and prepayment penalties. Both can be avoided. But a prepayment penalty makes it more challenging to save money on interest if you can make the payments ahead of schedule.
Potentially high interest
Interest rates on home improvement loans can be as high as 36 percent, especially for people with bad credit. The higher your interest rate, the more you will have to spend each month to finance your home projects.
Some loans are secured
Most personal loans are unsecured, meaning no collateral is required. However, some loans are backed by the equity in your home or by another asset, such as a savings or investment account.
If you cannot pay your loan and default, the lender can seize your collateral to pay off your debt. Even if a secured loan has lower interest rates, the risk potential is much higher and that is an important factor to consider.
Possible negative impact on credit
Applying for a home improvement loan will result in a small drop in your credit as the lender cracks down. Increasing your credit utilization by using a HELOC or credit card can also lower your credit score.
And if you miss payments or default on your loan, your lender will likely report it to the credit bureaus. Missed payments can remain on your credit report for up to seven years. And the better your credit was before, the further it will decline.
When should you get a home improvement loan?
Taking out a personal loan for home improvements may make sense in the following scenarios.
- You need money quickly to cover emergency repairs to your home. Unsecured home improvement loans generally have high financing rates, which can make them a better financing option than some alternatives.
- You are paying for a one-time home improvement project. If you need to borrow a lump sum to finance a project, a personal loan may be a good idea. For ongoing projects, consider a credit card, line of credit, or HELOC.
- You would rather not run the risk of losing collateral. A personal home improvement loan is typically unsecured, so you don’t risk losing an asset such as your home.
Types of Home Improvement Loans
There are several types of home improvement loans that go beyond just personal loans.
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Current average interest rate: About 12.2.
Interest rates for unsecured personal loans are typically higher than those of secured loan types, such as home equity loans and HELOCs. But in return they offer a number of benefits. Financing times are faster because the lender doesn’t have to assess the value of your home, which also means there are no closing costs. Because your interest rate is fixed, you get a predictable payment. The downside is that the rates you receive and whether you qualify at all depend heavily on your credit score, not the value of your home. Few lenders offer repayment terms of more than seven years, which can make payments on large projects unmanageable. And, unlike a HELOC or home loan, you can’t deduct the interest on personal loans from your taxes.
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Current average interest rate: About 8.5%.
Just like a personal loan, a mortgage loan pays out one fixed amount that you pay back in fixed monthly payments. You put up your house as collateral, which reduces the interest rate. This can also make it easier to qualify for a home equity loan if you have bad credit. But if you default, you could lose your home. Additionally, closing costs are typically high.
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Current average interest rate: About 9%.
A HELOC is a secured loan and revolving line of credit, meaning you withdraw money as you need to. Interest rates are often low, but usually variable and therefore fluctuate with the market. As with mortgage loans, the biggest disadvantages are that you can lose your home if you can’t pay what you owe, and closing costs can be expensive.
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Current average interest rate: About 7%.
When you refinance, you replace your current mortgage with a new mortgage and interest rate. Using a cash-out refinance, you take out a new mortgage for more than you owe on your home and use the difference to finance your home improvement project. But closing costs can be high, and it may not make sense if the interest rate is higher than what you pay on your current mortgage loan.
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Current average interest rate: Fixed; market rate.
This government loan is guaranteed by the Federal Housing Administration (FHA) and specially designed for home improvement, renovations and repairs. The maximum amount is $25,000 for a single-family home, lower than most of your other options. Depending on the amount borrowed, you may need to provide collateral. But if you’re a low- to moderate-income homeowner, this may be the best approach.
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Current average interest rate: 20.75%.
At first glance, getting a new credit card may not seem like a good idea for financing home improvements due to the high interest rates. But if you have good credit, you may qualify for a card that offers a 0 percent introductory APR for a promotional period. These periods usually last between 12 and 18 months.
But if you have a balance at the end of the promotional period, you will have to start paying interest. That makes this strategy best for short- and medium-term projects where you have a good estimate of your expenses.
it comes down to
Carefully consider the potential impact that taking on more debt will have on your financial health. Even before you compare lenders and research the details, perform a financial audit to ensure you can handle more debt.
If a personal home improvement loan isn’t the right route for your financial needs, consider alternatives such as a mortgage loan, HELOC, credit card, or taking the time to build your savings.
