How Do Home Improvement Loans Work?

Home improvement projects can be exciting to think about and pursue, but the costs of these renovations feel daunting to some homeowners. Not everybody has the money to pay for such upgrades upfront, which is why many homeowners choose to apply for a home improvement loan or a comparable option.

Let’s take a closer look at what a home improvement loan is, the most common types of home improvement loans that homeowners use, and how to go about getting this home renovation loan or a similar type of financing.

A home improvement loan is typically an unsecured personal loan or another type of loan that a homeowner uses to repair, improve or remodel their home. Various types of financing can serve as a home improvement loan, loosely speaking, but it’s best to choose one based on your personal finances and project costs.

Just like with mortgages, auto loans and other types of financing, you can typically borrow the money you need for your home improvement project and pay back the full amount over time. Getting a home improvement loan is similar to most loans in that the process starts with finding the right lender for the type of loan you need and agreeing on a repayment plan that works for your situation.

Whatever your reason for making home improvements, and depending on your financial circumstances, you can fund these improvements in multiple ways – whether the upgrades be home repairs, remodeling or changes that will simply increase the home’s value for purposes of resale. See if any of the payment options outlined below would work for you.

Personal Loan

The way a personal loan works is by giving you, as a homeowner, a lump sum of money you’ll pay back over a series of monthly payments. Although personal loans often pay for home renovations, you can use a personal loan for many reasons.

Unlike some other home improvement loans and other home improvement financing options, personal loans are usually unsecured and not backed by any collateral. If your home improvement projects are relatively small and you can pay off your debt in a fairly short time frame, you might consider getting a personal loan.

Interest rates for personal loans are typically fixed and are determined by the lender reviewing your credit report. Like with other loans, a higher credit score will likely mean a lower interest rate.

Cash-Out Refinance

If you’ve built enough equity in your property and your interest rate is higher than the market’s, you can accomplish two goals through a cash-out refinance. With this method, you refinance your existing mortgage and convert your home’s equity into cash you can put toward your home improvements. This way, you won’t need to take on a personal loan or second mortgage.

However, since you’re refinancing your existing mortgage with a new home loan, you’ll need to go through the application process again and pay closing costs. And if your credit history includes negative entries like missed payments or outstanding debts, your lender might not approve you for a cash-out refinance.

Home Equity Loan

By contrast, a home equity loan, or a second mortgage, is a separate loan you take on. With a home equity loan, your lender will approve you for a lump sum equal to a portion of the equity you’ve built in your property – your equity being the difference between your home’s worth and the amount you still owe on the mortgage.

For example, if your home is valued at $300,000 and you owe $100,000 on your mortgage, you have $200,000 in home equity. With a home equity loan, you can borrow a portion, but not all, of that equity to put toward home improvements.

As with your first mortgage, you’ll pay the loan amount back over a period of time with a fixed or adjustable interest rate. If you feel confident you can pay off this second mortgage and have the equity built up, a home equity loan might work for you. Be mindful that a default on the loan can risk foreclosure or other legal consequences.

Rocket Loans^SM doesn’t currently offer home equity loans, but our trusted sister company Rocket Mortgage^® does!

Home Equity Line Of Credit (HELOC)

A home equity line of credit, or HELOC, also utilizes your home’s equity, but as collateral instead of cash. With a HELOC, your lender sets a borrowing limit – usually 80% of your home’s value – that you can repeatedly borrow from over a period of time known as the draw period. The repayment period will follow the end of the draw period. Some loan terms stipulate that the entire loan amount is due at the end of the draw period in a lump sum or balloon payment.

Because the line of credit allows you to borrow multiple times up to your limit, a HELOC is a smart choice if you’re not sure how much you’ll need for all of your repairs or renovations. If you do have a good idea of the amount you’ll need, perhaps consider one of the other loan options discussed.

Rocket Loans doesn’t currently offer HELOCs.

Government Loans

Depending on the type of improvement you’re looking to make to your home, you may qualify for a government loan. A Title 1 loan, for example, can be used for items that boost your home’s livability. Government loans can be available for accessibility upgrades, new appliances or energy-efficiency improvements.

With a government loan, you may be eligible to borrow up to $25,000 for a single-family home. You won’t need to have any equity in your home to qualify, but you’ll have to live on the property for at least 90 days. Also, any Title 1 loan over $7,500 requires using your home as collateral or having a deed of trust on the property.

Credit Card

You always have the option to charge the costs of your home improvements to your credit card. This is riskier because credit cards carry high interest rates that can cost you more in the long run unless you fully pay off the charges each month.

We recommend using a credit card over a loan if you only need to borrow a small amount and want a flexible payment option. If you can’t pay off the balance over an extended period of time, it can be difficult, but not impossible, to get out of credit card debt.

Cash

One option for funding home improvement projects is to save money and pay for the renovations with cash. This can happen through careful budgeting and a little patience, helping you avoid interest fees and other charges that may come with using a loan.

Unfortunately, using your savings account to pay for your renovations could leave you empty-handed in the event of an emergency. If you decide to use cash, make sure you leave some funds behind in case your project goes over budget.

Many of these home improvement loan options require a decent credit score – a personal loan typically requires a minimum score of 600 to 700, for example – but having poor credit isn’t necessarily the end of the road. You have ways to improve your credit report, and, additionally, various home improvement loan grants and programs are available as long as you qualify.

These government-backed programs include:

• HUD grants and loans: Visit the Department of Housing and Urban Development (HUD) website for more information on its home improvement programs.
• FHA rehab loans: If you have a credit score of at least 580, you may be eligible for an FHA 203(k) loan. Visit the HUD website for more information.
• USDA programs: The U.S. Department of Agriculture offers remodel incentives for rural properties through its Section 504 repair program. Contact your local Rural Development office for more information.

Learn more about home improvement loans from the answers to these frequently asked questions.

What types of home improvement loans are best?

Choosing the best financing option for your home improvements will depend largely on your personal financial situation. If you have equity in your home, choosing a home equity loan or HELOC may prove to be the best option for your needs. However, if you don’t have much or any equity, a better option might be a home improvement personal loan.

Is a home improvement loan tax-deductible?

Typically, home improvement loans aren’t tax-deductible. However, if you’re making significant renovations to your home using a home equity loan or refinance, some costs may be deductible. Keep in mind that only significant renovations are likely to be eligible. You should consult your tax professional regarding your specific situation.

How can I get the best home improvement loan rates?

The rates for your home improvement loan will largely depend on your credit score and credit history. Lenders will look over your credit report to determine how big of a risk you could be as a borrower.

A higher score tells the lender you’re reliable and trustworthy with your repayments, while a lower score indicates you could have difficulty paying back the loan. Building good credit is the key to getting the loan you want, and maintaining a high score will make it easier for you to borrow however much you may need in the future.

There’s a lot to consider when choosing from your loan options. Every choice has its pros and cons, but the key factors to consider are:

• How much do you need to borrow?
• Can you make your monthly payments or pay the amount back in full?
• Do you require flexibility in your repayment method?
• What loan terms would most benefit your financial situation?

It’s important to review all your loan options and your finances before deciding on the best way to make the home improvements you’ve likely been dreaming about.

If a personal loan sounds like the best option for you, apply now with Rocket Loans.