A higher resale value of your home is one of the many rewards for carrying out home improvements and renovations. But remodeling projects cost money, and financing them can be expensive, depending on the amount you borrow and the type of loan you use.
Options for home improvement financing include home equity loans (HELOCs), home equity lines of credit, and cash-out refinancing. These types of financing allow homeowners to borrow against the equity they have built up in their home. Other financing options are personal loans, credit card financing, and government programs. Any of these could be the best option depending on the circumstances.
Here’s what homeowners need to know about the different types of home improvement loans and what factors they should consider before settling on a lender.
1. Home Equity Loans
If you have built up equity in your home, which means you have paid off a portion of your mortgage, a home equity loan could be the right choice to finance home improvements. To find out how much equity you have, subtract the balance due on your mortgage from the assessed value of your home. For example, if your home is worth $400,000 and you owe $200,000 on your mortgage, you have $200,000 in equity. A bank will let you borrow up to a certain percentage of that amount — up to 100% in some cases.
A home equity loan acts like an additional mortgage, where the homeowner pays back the loan in monthly payments. The payments are in addition to the original mortgage payments. Home equity loans often have low fixed interest rates because the home is used as collateral for the loan. However, there are closing costs to consider that could be between 2% to 5% of the loan amount.
On the plus side, home equity loans usually qualify for the mortgage interest tax deduction as long as the funds are used to substantially improve the home.
If you have plenty of equity and need a sizable amount to finance a big project, a home equity loan could make sense. You will receive a lump sum payment, and the improvements you make may increase the value of your home.
| Advantages of a Home Equity Loan | Disadvantages of a Home Equity Loan |
|---|---|
| Low interest and terms from five to 30 years | There are origination fees and closing costs |
| You can borrow up to 100% of your home’s equity | Funds are disbursed as one lump sum, so borrowers need to budget carefully |
| The interest is tax deductible | The monthly payments add to existing mortgage payments |
💡 Quick Tip: Before choosing a personal loan, ask about the lender’s fees: origination, prepayment, late fees, etc. One question can save you many dollars.
2. Home Equity Line of Credit (HELOC)
A home equity line of credit also borrows against the equity you have built up in your home. But the funding works more like a credit card and is not distributed as a lump sum payment. A bank will allow a qualified homeowner to borrow up to a preapproved limit and then pay it back. HELOC loan terms are typically between five and 20 years.
Interest rates differ for HELOCs because they are adjustable and rise and fall over the life of the loan. However, interest is only due on the outstanding balance — the amount borrowed — not the full credit limit.
The amount you can borrow through a HELOC depends on your credit score, income, and the value of your home. Your lender can change the loan terms, too. For example, if your credit score drops during the loan term, your lender may reduce the amount you can borrow.
One advantage of a HELOC is that you can use funds from the line of credit, make payments, and then borrow again. A HELOC is a better option if you have smaller projects to do over a longer term. You can borrow as you go, only pay interest on how much you use, and avoid paying closing costs.
| Advantages of a HELOC | Disadvantages of a HELOC |
|---|---|
| No closing costs | Interest rates may go up and down |
| Interest payments are tax deductible | Interest rates are typically higher than those for a home equity loan |
| You only pay interest on the amount you use | Your lender can change the amount you can borrow and the repayment terms |
3. Cash-Out Refinancing
Another option to fund home improvements is cash-out refinancing. In the case of cash-out refinancing, a homeowner takes out a new mortgage that is higher than their original mortgage. The borrower then pays off the original mortgage and uses the leftover cash to fund home improvements. The amount of cash they can access depends on the equity they have in the home.
For example, let’s say the homeowner currently owes $100,000 on a $300,000 mortgage. They take out a new mortgage for $350,000, pay off the old mortgage ($300,000), and now have $50,000 left to spend on home improvements. The catch is that their new monthly mortgage payments will be higher because they have increased the size of the loan, and they will have to pay origination fees and closing costs.
Money from refinancing does not have to be used to improve a home; it can be used to consolidate debt, pay for school, or anything else the borrower wants to use it for. Also, the cash is not considered income from the IRS and is not taxable.
Cash-out refinancing may be a good option if interest rates have dropped since you took out your original mortgage. You can take out cash and pay a lower interest rate on the new loan. You might also be able to reduce the term length of your original mortgage and pay off your home loan sooner. This will be the case if the total cost of your new loan including closing costs is less than the total cost of your original mortgage.
| Advantages of Cash-Out Refinancing | Disadvantages of Cash-Out Refinancing |
|---|---|
| You will still have one monthly mortgage payment | Your new mortgage will have a higher balance |
| You might be able to lower your interest rate and loan term | Your loan term will start from the beginning, so you will be paying off your mortgage for longer |
| You can use the cash for anything | If interest rates have gone up, your monthly payments may be higher |
4. FHA 203(k) Rehab Loan
An FHA 203(k) rehab loan is a loan taken out at the time of the home’s purchase. These loans are typically used for a fixer-upper, when the owners need funding right away for improvements. This could be the best type of loan for home improvements for big projects. The advantages of this type of loan for the borrower are that they have funds available for improvements from the outset, and they only have to pay back one loan with one set of closing costs.
These loans are also backed by the government and come with benefits. Borrowers can qualify with a less-than-stellar credit score (typically, a minimum of 620), and the down payment expected is lower than it would be for a traditional mortgage loan (as low as 3.5%).
Two things to remember are that the renovation costs must exceed $5,000 for the borrower to qualify for this type of loan, and the closing process can take a long time. Lastly, work covered under an FHA 203(k) loan must start within 30 days of closing, and projects must be completed within six months.
This type of loan may be worth considering if you are buying a fixer-upper that requires significant work, and your credit score qualifies you for this type of loan.
| Advantages of a FHA 203(k) Rehab Loan | Disadvantages of a FHA 203(k) Rehab Loan |
|---|---|
| One loan and one set of closing costs | Only old homes or homes in bad repair may qualify |
| Federally-backed with low interest rates and low closing costs | You are likely to be charged costly monthly mortgage insurance |
| You can qualify with a lower credit score | Cash must be used for specific home improvements |
5. Personal Loans
If you don’t have sufficient equity in your home to take out a home equity loan or a HELOC, a personal loan is an option. A personal loan will come with a higher interest rate, adjustable or fixed, because this type of personal loan is unsecured. Your home is not used as collateral. These loans are processed much quicker than home equity loans or HELOCs, sometimes the same day.
Personal loan terms are shorter, from two to five years, which will mean higher monthly payments, and you’ll have to pay closing costs.
These loans may work if you lack equity or if you have an emergency, such as a broken water heater or HVAC system. That said, they are probably one of the most expensive borrowing options.
| Advantages of a Personal Loan | Disadvantages of a Personal Loan |
|---|---|
| Fast financing | Higher interest rate than mortgage loans |
| You can qualify for a good interest rate even with an average credit score | Shorter terms, which increases monthly payments |
| Your home is not used as collateral and is not at risk | Fees and possible prepayment penalties |
6. Credit Cards
A credit card can be used for financing, and it’s a fast, simple way to access funds. The amount you can spend on improvements will depend on your credit limit (although you could use multiple cards), and the interest charges are likely to be much higher than other financing options.
A credit card can be a good option if you think you can finish your renovations quickly and pay off the balance on the card. Look for cards with an introductory 0% annual percentage rate (APR). Some cards allow you up to 18 months to pay back the balance at that introductory rate. If you can pay off the balance by the deadline, that’s interest-free financing. However, check for fees and other hidden costs.
The danger here is that if you don’t pay off the balance by the end of the interest-free rate, the interest charges can skyrocket. That’s why credit cards should not be used for long-term financing.
A credit card can be a great option for home improvement financing if you can find one with a low introductory rate, low fees, and you are confident you can pay off the balance within the introductory rate period.
| Advantages of Credit Card Financing | Disadvantages of Credit Card Financing |
|---|---|
| Fast financing | High interest rates, particularly after a low introductory interest rate period has expired |
| Some cards offer 0% introductory rates | Possibly low credit limits |
| Less paperwork | High fees |
7. Government Assistance Programs
The federal government has grants and programs that can help homeowners pay for renovations. Two home renovation loan options are Title I loans and Energy Efficient Mortgages. Lenders for Title I property improvement loans for your state are listed on the U.S. Department of Housing and Urban Development’s website.
Title I Loans
An FHA Title 1 loan is a fixed-rate loan used for home improvements and rehabilitation. Loans under $7,500 are usually unsecured, but bigger loans may use your home as collateral. These loans may be used in conjunction with a 203(k) rehabilitation mortgage.
The maximum loan terms are between 12 and 20 years, and loan amounts are $7,500 to $60,000, depending on the home’s size and type.
The loan must be used for property improvements, and an FHA mortgage insurance premium of 1% of the loan amount will be added to your interest rate. There is no minimum credit score required, but your debt-to-income ratio may factor into your loan terms.
Energy Efficient Mortgage
FHA’s Energy Efficient Mortgage program (EEM) finances energy-efficient improvements with their FHA-insured mortgage. The borrower must qualify for the loan amount used to purchase or refinance a home. However, they’re not required to be qualified on the total loan amount that includes the amount used to finance energy-efficient improvements. The FHA insures the loan to protect the lender against loss in the event of payment default.
Starting in 2023, homeowners can also get tax credits for some energy-efficient updates, including windows, insulation, new doors, heat pumps, and air conditioners.
These types of programs will reduce the cost of financing for home improvements and are great options if you meet the criteria.
| Advantages of Government-Assisted Financing | Disadvantages of Government-Assisted Financing |
|---|---|
| Low interest rates | Financing must be used for property improvements. |
| Broad range of loan terms | Strict qualification standards |
| Tax credits | Larger loans may require your home as collateral. |
How to Decide the Best Type of Home Improvement Loan for You
If you’re trying to decide what home improvement loan is best for you, consider the following factors:
Are You Purchasing a Fixer-Upper?
If you are buying a fixer-upper, check if you qualify for either an FHA 203(k) rehab loan or a government-assisted program. You may get cheaper financing this way.
Do You Need Funds Right Away?
If you need funds quickly — for example, you have a broken heat pump or HVAC system — a personal loan or credit card financing are options to explore.
Do You Have Equity Available?
If you have built up equity, a home equity loan or line of credit will provide cheaper financing than a personal loan and over a longer term, so that your monthly payments will be lower. A cash-out refinancing loan might also mean that you could lower your payments and reduce your term if interest rates have dropped significantly since you took out your original mortgage.
How to Get a Home Equity Loan
The first step in getting a home equity loan is to decide which loan is best for your situation. Next, find a lender with the best terms and fill out an application to see if you qualify.
1. Check Your Financial Health
The better your credit score, the better the loan terms will be. If you can boost your credit score before you apply for financing, you’ll boost your chances of getting a better deal. Lenders will also look at your debt-to-income ratio when setting the interest rate and term, so lowering your debt before you apply for a home improvement loan can help lower the cost of your financing.
2. Compare Lenders
You should contact a few different lenders to compare their rates and loan terms. Look for benefits, such as rate discounts for enrolling in autopay, and watchouts, such as late payment fees and minimum loan amounts.
3. Gather Documentation
You will need to submit a few basic pieces of information when you apply for a loan. As a general guide, you will need:
• Proof of income, such as W-2s or 1099s, bank statements, pay stubs, or tax returns.
• Proof of residence, such as your Social Security number and utility bills.
Your current debts, housing payment, and total income will also play a role. Be sure to have all the information your lender may need on hand when you apply to speed up the application process.
💡 Quick Tip: With home renovations, surprises are inevitable. Look for a home improvement loan with no fees required — and no surprises.
4. Apply for Prequalification
Some lenders will prequalify you, which will tell you your interest rate and how much your monthly payments will be. Prequalification should not affect your credit score, whereas a formal loan application could. Applying for too many loans in a short space of time could lower your credit score.
5. Complete the Loan Application Process
Your loan application might be fully online, via phone and email, or in person at a local branch. In cases where you are borrowing against equity, your lender may require a home appraisal. Provided your finances are in good shape, the lender should approve your application, and you’ll receive funding.
How Your Credit Affects Your Home Improvement Loans
Your credit score will affect the total cost of a home improvement loan. The higher your score, the less of a risk you pose to a lender, so the better the loan terms will likely be for a mortgage or long-term loan. The same goes for credit cards and personal loans. Also, if you have good credit, you’ll probably have an easier time securing a home improvement loan.
Can You Use Home Equity Loans for Non-Home Expenses?
Home equity loans and HELOCs are flexible and can be used for anything, not just home expenses or renovations. However, these loans are best suited for long-term, ongoing expenses like home renovations, medical bills, or college tuition.
The Takeaway
The types of loans for home improvements include loans based on the equity you have built up in your home, such as a home equity loan, a HELOC, or cash-out refinancing. You can also use personal loans, credit card financing, and government programs. Loans based on equity tend to cost less over the loan’s lifetime, but they also tend to have longer loan terms. Equity-based loans also tend to be best when you need to borrow a larger amount, because you can spread out the cost over a longer period.
A personal loan will have a higher interest rate and a shorter term, but the higher your credit rating, the better the interest rate tends to be. Alternatively, credit card financing is favorable if you need funds quickly, the amount you need is not too high, and you can take advantage of a 0% introductory rate and pay off the balance before the rate expires.
Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. Checking your rate takes just a minute.
FAQ
What type of loan is best for home improvements?
The type of loan that is best for home improvements depends on your finances and how much you need to spend. If you hold a fair amount of equity and need a sizable amount of cash, a home equity loan, HELOC, or cash-out refinancing may be good options. Cash-out refinancing might be particularly appealing if interest rates have dropped, and you can refinance with better loan terms.
If, on the other hand, you have a smaller project that you expect to complete in a short timeframe, using a credit card that gives a 0% interest rate for a period could be the way to go.
What is the best renovation loan?
If you’re taking on a big project, buying a fixer-upper or planning to renovate an older home, you may want to consider the FHA 203(k) mortgage. The 203(k) rehab loan lets you consolidate the home and renovation costs into a single remodel home loan and avoid paying double closing costs and interest rates.
If your home is newer or higher-value and you have equity, cash-out refinancing can be a good option, particularly if interest rates have dropped.
Should I use a personal loan for home improvements?
Personal loans are a more expensive option for home improvements, especially if your credit score is average. However, using a personal loan for home improvements might be the best option if you don’t have a lot of equity to borrow from.
Are home improvements tax deductible?
Home improvement loans are generally not tax deductible. However, if you use a refinance or home equity loan, some of the costs might be tax deductible. Check with a CPA or tax specialist.
What credit score is needed to get a home improvement loan?
Credit score requirements for a home equity loan depend on the lender. A credit score in the mid-600s might be enough to be approved by some lenders, while others might not approve you with a score above 700. Lenders consider many factors, including your debt-to-income ratio and equity in the home, when considering you for a home equity loan.
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