Home Improvement Loans: A Quick Guide

Home improvement loans provide the financial means to make your dream home a reality. Our quick guide to home renovation loans will help you navigate your options so your remodeling doesn’t become a nightmare. Below, we’ll explore the various types of home improvement loans available and identify the circumstances in which each makes the most sense.

What Are Home Improvement Loans?

Home improvement loans are options for financing home repairs, renovations, expansions, or upgrades. These loans can be used for major projects, such as converting your home to an open concept layout or smaller tasks, like wallpapering a bedroom. Some types of home improvement loans are explicitly structured by lending institutions for renovation projects, offering lower interest rates or tailored repayment terms. Other, more flexible options, such as personal loans, may be available but often come with higher interest rates. 

Types of Home Improvement Loans

There are several types of home improvement loans to consider, as well as loan alternatives if you don’t qualify for a traditional loan. Below is a quick snapshot of each loan type:

• Personal Loans: A home improvement loan is an unsecured personal loan, so the interest rate is higher with this option than those using your home as collateral. Your interest rate is based on your credit score; these loans are typically approved and funded quickly. Repayment periods are generally shorter, often ranging from 2 to 7 years.

Best for: Smaller projects such as repainting, new flooring, or upgrading fixtures. Ideal for quick funding without tapping your home’s equity.

• Home Equity Loans: These home renovation loans are based on the equity you have in your home and provide a fixed interest rate and fixed monthly payments. It’s essentially like a second mortgage. The interest rates are relatively low since the loan is secured by your home, but the loan amount is restricted to the equity in the home. Repayment is usually structured as 5-15 years.

Best for: Medium to large projects, such as kitchen or bathroom remodels, adding a deck or installing solar panels. Works well when you need a lump sum for major renovations.

• Home Equity Line of Credit (HELOC): Similar to a credit card, this option allows you to borrow a certain amount and pay off interest/pay down the principal monthly. In fact, like a credit card, you can borrow money and repay against the line of credit multiple times during the draw period. Interest rates are usually variable and based on your credit score. Repayment periods are generally longer in this option.

Best for: Ongoing or phased projects, like a room-by-room remodel or projects where you may not know the total cost upfront. Ideal for long-term renovations.

• Cash-Out Refinancing: With this home improvement loan, you’ll refinance your mortgage to be higher than what you owe. Then, you use the difference to pay for your home improvements. Interest rates on a “re-fi” are lower than some options but higher than others, and the repayment period is the length of the new mortgage, typically 15, 20, or 30 years.

Best for: Large-scale home improvements, such as adding new rooms or significant exterior renovations. Ideal when you’re already refinancing the mortgage and want to bundle the renovation costs.

• FHA 203(k) Loans: These government-backed loans are available to homeowners with little or no home equity and offer fixed rates. Like refinancing, these home repair loans use the home as collateral and replace the original mortgage. The interest rates are lower than for unsecured loans, and the repayment is generally 15 or 30 years.

Best for: Purchasing and renovating homes that need substantial work. Good for major structural repairs, such as roof replacements or modernizing outdated homes.

When to Use a Home Improvement Loan

Home improvement loans can be highly beneficial in several circumstances. Just consider carefully the impact the monthly payments will have on your budget.

• Major Renovations: When you’re planning large-scale renovations, a home renovation loan provides the necessary funding without draining your savings. By spreading the payments out over several years, these loans make significant investments in the home accessible to many. Home improvements can significantly increase the home value, offering a chance to recoup the investment when you sell.
• Urgent Home Repairs: Unexpected issues such as a leaking roof, a cracked foundation, or burst pipes require immediate remedies to prevent additional damage from occurring. A home repair loan provides fast access to necessary funds. Choosing a loan over a credit card, which typically has much higher interest rates, can save significant money in the long term. Personal loans may be approved and funded within days.
• Energy-Efficient Upgrades: Solar panels, new insulation, or smart home systems come with high upfront costs, but they also offer long-term savings. In addition to utility bill savings, lowering your federal tax credits for energy-saving improvements may also factor into future savings. Loans for renovation can help you take advantage of the savings upgrades without having to wait and save. 

How to Qualify for a Home Improvement Loan

To qualify for a home improvement loan for repairs or renovations involves three common criteria:

• Credit Score: You’ll need a good credit score to qualify for most home improvement loans. Some lenders won’t consider those with credit scores below 650. If you have sterling credit, you’ll enjoy favorable interest rates. However, FHA 203(k) loans may offer more lenient terms, making them an attractive option for those with problematic credit.

• Income: Lenders assess your income and your debt-to-income ratio to ensure you have the means to repay the loan. The higher and more stable your income, the better your interest rates, terms, and loan amounts will be.

• Home Equity: The amount of equity in your home will be evaluated for secured home improvement loans, like home equity loans or HELOCs. Typically, lenders require that you have at least 15-20% equity in your home before they will lend against it. The more equity you have, the larger the loan amount you will qualify for.  

Pros and Cons of Home Improvement Loans

When considering taking out a loan for renovations, carefully weigh both the pros and cons to make the best choice for your circumstances:

Pros of Home Improvement Loans

• Quick access to funds for immediate repairs or upgrades
• Potential to increase home value and equity
• Flexible loan options for projects of all sizes
• Some options, such as personal loans, don’t require collateral
• Interest payments and energy-efficient upgrades may both qualify for tax deductions
• Long repayment terms spread out the financial burden through monthly payments

Cons of Home Improvement Loans

• Secured loans require your home as collateral, putting your home at risk
• Interest rates vary widely depending on credit score and loan type
• Variable interest rates may climb over the course of the loan
• Monthly payments increase the household budget
• Easy borrowing can lead to over-improving, where the renovation costs exceed the increase in home value

Regardless of your borrowing method, there are potential risks involved – for both you and your lender. If your home improvement loan is tied to your home’s equity or any other personal collateral, you could risk foreclosure if you default on your payments. Be sure to consult your lender for more details, and consider using a planner or online calendar to stay organized with your payments.

Ready, Set, Renovate!

When you’re ready to start your renovation project, Neighborly® is your go-to resource for the services you need to get it all done! Whether you need professional painting services, new window installation, plumbing or electrical upgrades, Neighborly connects you with the best local professionals in the business.  Best of all, your satisfaction is ensured because we back their work with the Neighborly Done Right Promise™. Visit our home page to explore Neighborly home service professionals in your area and schedule service today!

This article is intended for general informational purposes only and may not be applicable to every situation. You are responsible for determining the proper course of action for your home and property. Neighborly is not responsible for any damages that occur as a result of this blog content or your actions. For the most accurate guidance, contact the applicable local Neighborly home service provider for a comprehensive, on-site assessment.