5 Types Of Home Improvement Loans

A home improvement loan can be a good option for financing necessary repairs, renovations and even remodels. With five home improvement loan options to choose from, you will need to research lenders and determine if a home improvement loan is a good idea.

5 loan types for home improvement loans

There are five types of home improvement loan you can consider when beginning your shopping journey. While all leave you with a finished project, some may fit your situation better than others.

Home equity loan

Funded by the equity in your home and received in a lump sum, a home equity loan usually has a fixed interest rate and can be repaid anywhere between five and 30 years. Lenders will generally allow you to borrow up to 85 percent of your home’s equity for the project.

Borrowers 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 that, since the loan is secured by collateral, you typically get lower interest rates than with other types of financing. On the other hand, using your home as collateral isn’t something you should take lightly. Defaulting on the loan could come with some serious consequences, including foreclosure.

Home equity line of credit (HELOC)

A HELOC is another way to tap into your home’s equity. It allows borrowers to withdraw funds as the need arises for a set period. Interest rates can be variable or fixed.

Although these can be used for various financing needs, they are an excellent way to afford home remodeling as funds can become available for an ongoing home project. This is because you can continue to draw from the line of credit as you need until the draw period closes.

When comparing HELOC options, pay close attention to interest rates, terms and potential fees. Additionally, HELOCs also use your home as collateral, so it’s something to keep in mind when thinking about this type of financing.

Personal loan

A personal loan can be found from a range of lenders. Terms range from two to seven years, and rates will generally be between 6.70 percent and 36 percent.

Since a personal loan is typically unsecured, you don’t risk your home if you default. However, this results in a higher interest rate — and you will need good to excellent credit to qualify for a larger loan.

Monthly payments also tend to be on a fixed schedule. A home improvement loan is funded as a lump sum, which means you have less flexibility than with a credit card or personal line of credit. The tradeoff for predictability is the fact that you may need to borrow more if your project costs exceed your budget.

Cash-out refinancing

To qualify for cash-out refinancing, you apply for a new mortgage on your home and then, pending approval, you will get an updated loan which is then used to pay off your older loan. The cash comes in the form of the “extra” amount found in the equity of your home.

Similar to home equity loans, this funding tends to be available shortly after closing and can be up to 80 percent of the value of your home.

That said, make sure you run the numbers before taking the plunge with a cash-out refinance. Not only are they secured by your home, but you will most likely end up with a higher mortgage payment.

FHA 203(k) rehab loan

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).

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.

How to get the best home improvement loan

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 cost will be. However, opting for a shorter term will mean paying less interest. Weigh both options when shopping for a lender.

Next steps

A recent Bankrate survey found that 25 percent of Americans have delayed home improvements or renovations due to the current state of the economy. If you are ready to invest in a project, you do have options.

Do your research to determine which loan option is best. 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.