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Q: I’ve heard that there is financing available for making repairs or additions to homes. But how do I know which types of home improvement loans are best for me?
A: There are six main types of home improvement loans: home equity loans, home equity line of credit (HELOC), personal loans, cash-out refinancing, credit cards, and the FHA 203(k) Rehab Loan. Each of these comes with its own benefits and drawbacks. For instance, some loans require that you use your house as collateral in the loan (more on that below), and some loans are better for smaller projects with fewer expenses, just for starters. Below we’ll cover each loan type in detail and when it makes sense to use that type of loan for home improvement (which are different from home loans).
1. Home Equity Loan
Home equity loans are one of the most popular types of home improvement loans for financing a home project. A survey from LendingTree found that 48.59 percent of people seeking either a home equity loan or a home equity line of credit (more on that later) were using that financing for home improvements. A home equity loan is in addition to your mortgage, and the lender uses the home as collateral on the loan. This means you secure the financing with the value of your home, so if you don’t pay the loan, the lender will take your home as payment of the debt. This type of loan is often called a “second mortgage,” since people get the loan for a certain amount of money and must repay that money over a certain time period, usually in equal monthly payments. Keep in mind, that amount you borrow also comes with a certain interest rate you have to pay as well. The interest rate is determined in part by the borrower’s income, credit history, and even the value of the home. According to the Federal Trade Commission, many lenders don’t want people to borrow more than 80 percent of the equity in their home.
Homeowners secure this type of home renovation loan through lenders and brokers. There are also several key terms to know, and it’s important to know all parts of the deal before taking on a loan. If you don’t understand, ask a representative of the lender or broker about the terms of the loan so that you are fully aware of the responsibilities of paying off the loan. The most important part of the loan is the annual percentage rate (APR), which is the total cost people pay for credit, sometimes referred to as home improvement loan rates. Basically, it’s the fees you pay above and beyond repaying the loan amount. The APR includes the interest rate and other fees, such as broker fees. A lower APR can mean lower monthly payments. These are also typically fixed, meaning they don’t change over the life of the loan. People also pay interest on the entire loan amount.
So when does it make sense to get a home equity loan to use as a renovation loan? In general, home equity loans make the most sense for people who have been paying on their home for a long time or have their home completely paid off. These people have the most equity to borrow again without going over that 80 percent borrowing recommendation mentioned above. Also, if someone has their home paid off, they might be in a position to take on that additional monthly payment or “second mortgage.” Because that person would be paying interest on the entire amount available to them, it also makes sense to use this type of loan for one large expense, like a new roof.
2. Home Equity Line of Credit (HELOC)
Often spoken in the same breath as the term “home equity loan,” the home equity line of credit (HELOC) also uses the home as collateral in the terms of the loan. However, where the home equity line of credit differs is that it is not a one-time loan, but a revolving line of credit. It works much like a credit card, except the line of credit is secured by the home, similar to a home equity loan. How it works is the lenders approve people for a certain amount of credit. A benefit to this type of financing is that it means people can borrow what they need, whenever they need it, as long as they stay under their credit limit. Homeowners would access that line of credit by writing a check or using a credit card that is connected to their home equity line of credit account. However, that line of credit is not typically available forever. Many lines of credit that work this way have a draw period, where people can draw from that account within a certain time frame. In some cases, homeowners can renew the line of credit, but eventually, they have to start repaying the line of credit. Depending on the terms, that could mean paying the entire outstanding balance or making payments over a certain period.
Another factor to keep in mind is that the interest rates or payments can be variable, meaning they can increase or decrease at any time. Also remember that since the home is considered collateral, if you can’t make payments or they’re late, the lender can repossess your home. Also, if you decide you sell your home, all your outstanding debts on the home equity line of credit may come due at the time that you sell your home.
All the details above might make it sound like a home equity line of credit isn’t such a good idea. However, there are circumstances in which such a type of financing can make sense as a loan for home improvement. One benefit to the home equity line of credit is that people are only paying interest on the money they use, not the entire amount that they can access, unlike a home equity loan. Some people consider it helpful to know they have access to a certain line of credit when they need it, but don’t feel like they have to use the whole amount. As such, the HELOC is one of the best types of home improvement loans for smaller ongoing home expenses or projects like replacing siding or maintaining landscaping.
3. Personal Loan
Another way to access funds for improvements is the personal loan. This can be one of the better types of home improvement loans if you’re uncomfortable with using your very own home as collateral against a loan. This type of loan is fairly straightforward: Someone borrows a set amount of money and then pays it back with interest on a set schedule. The main components of the loan, then, are the amount of money borrowed, the interest rate, the term of the loan (such as 6 months or 5 years), the amount of interest someone ends up paying, and the monthly payment they are then responsible for until the loan is paid off in full. Service Credit Union gives the example of a $20,000 loan with an APR of 8.24 percent. If the loan is paid over the course of 5 years, that person is paying a total of $4,552.00 in interest, and their monthly payment is $407.93 for those 5 years. This type of loan is what’s known as an unsecured loan, which means the individual is not offering up any personal assets as collateral on the loan. The amount of money can be used for anything, meaning it’s one available option for those home improvement goals.
It’s very important to shop around for personal loans, as it’s easy to find a wide array of interest rates and terms during which someone would pay back the loan. You can find personal loans through online lenders, credit unions, or banks, and you can even compare rates side by side online. You should also keep in mind your credit history, since the company offering you the loan will pull a credit report. The financial institution then uses that information to help determine rates and the amount of money it will lend you.
Personal renovation loans work for many people and have a wide array of benefits. They’re especially a good option for someone who has a good credit score, as they could secure higher borrowing limits with lower interest rates with that good credit history. The money can be used for any purpose, so someone could use part of it to pay for home improvements and then use any remaining to consolidate debt or even pay for a wedding, for example. As mentioned, you are also not risking your home if you cannot pay or you make a late payment. However, it’s important to note that if you do not make your payments on a personal loan, it can have disastrous consequences for your credit score and the loan is typically turned over to a debt collection agency. As a final note, personal loans can often be easier to secure and require less paperwork than some of the other options on the list.
4. Cash-Out Refinancing
Cash-out refinancing is actually an option in which you get a whole new mortgage. It can come across as one of the most drastic loans for home improvements options on the list, but for people considering refinancing their home anyway, this can be a powerful tool for accessing extra funds for those home improvement projects. Basically, someone would trade equity in their home for a cash payout, but this option does count as a type of loan. People typically use this type of loan for cash at closing, debt payoff, paying off liens, and, yes, making home improvements. In this case, you would actually get a whole new mortgage that lets you borrow extra money as part of the terms of that new mortgage. In the new mortgage, the cash you take out and the the balance owed on your home loan make up your new loan principal. This means that your payments now “reset” and are almost entirely interest at the beginning. It’s worth noting that this option can result in a higher monthly payment or may extend the length of the mortgage to pay off both the loan amount and the cash borrowed. Additionally, this type of loan may involve closing costs.
You would access this type of financing by checking with either your current mortgage lender or looking at new ones. Mortgage companies can help homeowners understand what their refinancing options are, what their payments would end up being, how term lengths on their mortgage might change, how much money they can borrow, and what their interest rates would be. Homeowners might also be able to find specific loans for their unique situations, such as cash-out refinance loans through The Department of Veterans Affairs.
This is one of the home remodel loans options you need to consider very carefully. For instance, if someone is 40 years old and they end up renewing a 30-year mortgage so that they can refinance and get cash out of their equity, they’re now looking at paying a mortgage until they’re 70 years old. However, if they plan on taking a late retirement anyway, that might not be such a bad option. Especially if that cash out of their home’s equity can consolidate debt, they can get that dream pool area they’ve always wanted and they may be able to negotiate a lower monthly payment because interest rates may be lower at the time. Alternatively, they could also choose a 15-year mortgage. There are also some other hidden perks. For instance, homeowners can deduct home mortgage interest up to the first $750,000 of indebtedness. Higher limitations of up to $1 million also exist for indebtedness incurred before December 16, 2017, according to the IRS.
5. Credit Cards
One of the most common and no-fuss ways to get that financing for a home project is by accessing credit cards. Credit cards are easy to find and apply for, making this the simplest option on the list of types of home improvement loans. And people can get a wide variety of perks on them depending on the program, like cash-back amounts for gas purchases or travel rewards. A nice perk is that home improvement stores also have their own credit cards, meaning homeowners can see what their credit options are at the same time as planning that new home project. Some of these cards can even help people access in-store discounts while shopping, such as a certain percentage off purchases. That way, that project gets financed and homeowners can save on materials for the project. Even better, if you have a credit card already open, you don’t have to go through the hassle of applying for a new loan.
It’s important to keep in mind, however, that this can be a good option if renovations don’t require a massive amount of expense, such as putting in a stretch of fence or paying for those cans of paint. Interest rates on credit cards can be higher than loan amounts, so someone would technically be paying more for their renovation this way than with other certain types of loans for home improvement. If someone has a larger project, they might end up pushing their total available credit ratio too high, and that can negatively affect their credit score, according to Scott Credit Union. Homeowners also should keep an eye on their spending on their credit card so that the payments don’t get too large and unwieldy. This is also another option that is best for those with good credit scores. Higher credit scores can mean better interest rates on credit cards, especially if someone needs to apply for a new card to fund this particular project. With credit cards, be sure to look at those that offer introductory or no-interest terms. Some cards allow people to not pay any interest as long as they pay down the amount within a certain period, such as 6 months. Also, some cards may have completely interest-free introductory periods, eliminating the higher interest problem with credit cards, as long as you can pay off the balance in that no-interest period. You might also look into cards with no fees to set up and no annual fees, making credit cards an even more cost-effective option for loans for home renovation.
6. FHA 203(k) Rehab Loan
The tagline for this government program for home repair loans is “Turning ‘Fixer-Uppers’ into Dream Homes.” This option is for those needing the most extensive repairs on a home. This is the Section 203(k) loan program offered by the U.S. Department of Housing and Urban Development (HUD). The program is for financing the purchase of a new home or refinancing a current mortgage so that the mortgage includes the cost of repairs. You can find these programs through HUD-approved mortgage lenders. The Federal Housing Administration (FHA) insures the loans.
The program typically works by someone taking out a 15- or 30-year fixed mortgage or an adjustable rate mortgage (ARM) from a HUD-approved lender. The total amount of the mortgage includes the projected value of the home post-renovations while factoring in the cost of the work it will take to repair the home. One part of the loan pays for the home (or any debt if the home is refinanced). The remaining amount gets put into an interest-bearing account and gets released to the homeowner at certain intervals as the work continues. Those with this loan are required to use a minimum of $5,000 toward repairs of the home, and work is expected to be completed within 6 months of the loan closing, in most cases. Repairs need to be deemed eligible, and the first $5,000 covers taking care of the most pressing issues first, like addressing building code violations, making the home more modern, and addressing health and safety issues. For instance, if the roof is about to cave in, that first $5,000 goes toward repairing the roof. Luxury and commercial improvements can’t be made to a home under this program, such as adding swimming pools, gazebos, or tennis courts.
A huge perk of these types of home improvement loans is that the loan down payment is as little as 3 percent, making this one of the best home improvement loans if you have a fixer-upper. The program was created with low-to-moderate-income individuals and families in mind. So if you’re on a tight budget and have a fixer-upper on your hands, this program is a solid option to look into. This program can also be a great option for those who find a home in a location they love and see the potential, but know it needs extensive repairs, such as in the case of fixing up an old country home.For those who enjoy and appreciate a historical look, this is also a good way to return an older building back to its former glory. Note that this program does not apply to investment properties or cooperative units.
