Types of home improvement loans that suit your project

A home improvement loan can be a good option for financing necessary repairs, renovations, and even remodels. Also called renovation loans, there are six primary options to choose from. Once you know the scope of your project, you can research lenders and determine whether a home improvement loan is a good idea.

6 types of home improvement loans

While each loan option gives you a way to pay for your home improvement project, some may work better than others. The cost of your project, how much equity you have in your home, whether you already own the property, and your creditworthiness are some of the factors that influence what is best for your situation.

Mortgage loans

Home equity loans are ideal for people who have more value in their home than what is owed on the mortgage.

A home equity loan is financed by the equity in your home and is received in one go. This loan usually has a fixed interest rate and is repaid between five and thirty years. Lenders generally allow you to borrow up to 85 percent of the equity in your home.

You can apply for a mortgage loan through banks, credit unions or online lenders. The interest rates and terms and conditions offered depend on your creditworthiness.

Because the loan is secured by your home, you usually get a lower interest rate if you use a mortgage loan for a renovation. You may also be able to write off the interest at tax time, if the money is all used for home improvements.

A major disadvantage is that defaulting on the loan can have serious consequences, including foreclosure.

Home Equity Lines of Credit (HELOC)

A HELOC is another way to finance home renovations with the equity in your home. Unlike a mortgage loan, a HELOC works more like a credit card. This allows you to withdraw money as needed, for a specified period of time with fixed or variable interest rates.

HELOCs boast some of the lowest interest rates available, making them a great option for keeping your monthly payment low while your improvements are made.

They are an excellent way to finance ongoing home projects because you don’t have to use all the credit at once. You can continue to draw on the line of credit as needed until the draw period ends, which is usually after 10 years.

When comparing HELOC options, keep in mind ongoing fees and penalties for terminating your line of credit early. Like mortgage loans, HELOCs use your home as collateral, so you’re putting your home at risk if you can’t pay back the loan. Fortunately, you also get the same tax benefit if you use your HELOC solely to pay for home improvement costs.

Personal loans

You can finance a small or medium-sized home project with an unsecured personal loan. They can also be a good option for quick emergency home repairs, as personal loans typically offer fast financing, sometimes on the day you’re approved.

A personal loan is similar to a home equity loan in that you receive all the money at once and pay at a fixed rate. However, personal loans are typically unsecured, meaning you won’t risk your home if you default. They can be a good alternative to home equity loans or HELOCs if you don’t have enough equity to cover the costs of your renovation plans.

Personal loans are offered by various lenders. Terms typically range from one to seven years, and rates are generally between 7 and 36 percent, with bad credit personal loan rates typically at the higher end of the range.

Compared to home equity products, interest rates for unsecured home improvement loans are typically higher. The only exception is that rates for excellent borrowers can be similar to home loans.

Because a personal home improvement loan is funded in one lump sum, you have less flexibility than with a credit card, HELOC, or personal line of credit. This means you may need to borrow more if your project costs exceed your budget.

Cash-out refinancing

If you have a major home upgrade in your future, a cash-out refinance can spread the payment over 30 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 will receive the money as long as you have ‘extra’ equity in your home.

As with home equity loans, you receive all the money in one go and you usually opt for a fixed interest rate with a repayment term of up to 30 years. However, you usually cannot 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 is lower than the current mortgage rate. You may also pay higher closing costs because your loan amount is typically much higher than what you would borrow with a mortgage or personal loan.

FHA 203(k) rehabilitation loans

An FHA 203(k) rehabilitation loan can make both the purchase and renovation of your home possible, especially if you have less than perfect credit.

Backed by the Federal Housing Administration, an FHA 203(k) rehabilitation loan is a financing option that combines both the costs of purchasing the home and the costs of remodeling or repairing it. This single loan essentially does the work of two: it’s a mortgage and a home improvement loan.

Rates are based on your creditworthiness and income, and you can choose a 15- or 30-year fixed-rate mortgage or an adjustable-rate mortgage (ARM). Borrowers with bad credit can often qualify for these loans because FHA credit score standards are more lenient than other home equity options.

When you sign up, you have two options. The limited 203(k) loan is for projects valued at $35,000 or less 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.

Conventional renovation loans for mortgages

A conventional mortgage renovation loan is ideal if you need a larger loan amount than the FHA loan limits allow, or if you want to make luxury upgrades to your home that the FHA won’t allow.

Fannie Mae and Freddie Mac provide financing 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 combine the costs of your improvements in one loan. As an added benefit, 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 also have access to higher loan amounts with fewer restrictions on the types of renovations than with the FHA 203(k) program.

How to Get the Best Home Improvement Loan

To get the best rate on a home improvement loan, compare lenders and put yourself in the best financial position.

• Fixed or variable rate. Home improvement loans are available with fixed or variable interest rates. Fixed-rate loans typically have a higher upfront interest rate, but you avoid the risk of your interest rate increasing over time.
• Approval criteria. Consider approval requirements, such as your credit history, debt-to-income ratio, and your income, before applying for a home improvement loan. To get the best rates, you need excellent credit and a high income.
• Costs. Origination fees, application fees, and other required fees increase the cost of your loan. But even if a lender has high fees, check the annual percentage rate (APR). It can still be competitive even with fees.
• Project size. The size of your project – both in terms of cost and size – will influence your choices. A single project with a fixed budget benefits from home equity or a personal loan. Multiple projects with fewer fixed costs will benefit from a HELOC.
• Refund options. Most home improvement loans have a term of up to 30 years. However, a personal loan has a much shorter repayment period, which means that the monthly costs are higher. Always calculate the cost of your loan to estimate how much you will pay each month.

Next steps

Do your research to determine which loan option is best for the size and scope of renovations you have planned. Then consider at least three lenders to find one with the most competitive terms.

You may also want to consider other options, such as a high-limit credit card or a 401(k) loan. While these aren’t traditional, they can make sense if you want to take advantage of the benefits of a credit card or avoid a credit check.

As long as you approach finding a home improvement loan with care and dedication, you can bring your blueprints to life – with or without perfect credit.