Home improvement loans: 6 types and which is best for you

Compare the best home improvement loans for 2020

Home renovations can be spendy. The good news is, you don’t have to produce the cash out of pocket. 

There are a number of home improvement loans that let you finance the cost of your upgrades. 

For example, there are specialized home improvement loans like the FHA 203(k) mortgage. 

And there are more general loans — like a cash-out refinance or home equity loan — that give you cash which can be used for renovations or anything else. 

So, which home improvement loan is right for you? Find out here.

Explore your home improvement loan options (Apr 3rd, 2020)

The 6 best home improvement loans (Skip to…)

  1. Cash-out refinance — Best if you can lower your interest rate
  2. FHA 203(k) rehab loan — Best for older and fixer-upper homes 
  3. Home equity loan — Best for a big, one-time project
  4. Home equity line of credit — Best for ongoing projects
  5. Personal loan — Best if you have little home equity
  6. Credit cards — Best for smaller projects

See also: Home improvement loans FAQ

1. Cash-out refinance

One popular way to get money for home improvements is with a cash-out refinance. This involves refinancing your mortgage and taking cash out at closing. 

The money you get from a cash-out refinance comes from your home equity. You take out a new loan with a bigger balance than what you currently owe. Then you pocket the difference between the two.

A cash-out refinance is often best if you can reset your loan at a lower interest rate than your current mortgage. 

You may also be able to adjust the term to a shorter amount. For example, say you had 20 years left on your 30-year loan. You may be able to do a cash-out refi for a lower interest rate at only 15 years.

A cash-out refinance is best if you can lower your mortgage rate or shorten your loan term along with financing home improvements.

So, how do you know if you should use a cash-out refinance? Compare costs over the life of the loan, including closing costs. 

That means looking at the cost of the new loan including closing costs and interest until it’s repaid, versus the cost of keeping your current loan for its life and adding in the new loan costs and interest over its life.

Keep in mind that cash-out refinances have higher closing costs, and they apply to the entire loan amount, not just the cash-out.

So you’ll likely need to find an interest rate that’s significantly lower than your current one to make this strategy worth it.

Find low cash-out refinance rates here (Apr 3rd, 2020)

2. FHA 203(k) rehab loan

An FHA 203(k) rehab loan is a simpler way to finance home improvements. It bundles the mortgage and home improvement costs into one loan. With an FHA 203(k), you don’t have to apply for two separate loans or pay closing costs twice. 

FHA 203(k) rehab loans can be used either for purchase or refinance. And they’re backed by the government, which means there are special benefits: 

  • The interest rate can be fixed or adjustable
  • Your down payment can be as low as 3.5 percent
  • Most lenders only require a 620 credit score 
  • You don’t need to be a first-time buyer

But this loan is designed only for older and fixer-upper homes. Your lender has to be FHA-approved. And your renovation costs must be at least $5,000.

Check your eligibility for an FHA 203(k) rehab loan (Apr 3rd, 2020)

3. Home equity loan 

A home equity loan (HEL) allows you to borrow against the equity you’ve built up in your home. Your equity is calculated by assessing your home’s value and subtracting the outstanding balance due on your mortgage loan.

A home equity loan may be the best way to finance your home improvements if a) you have plenty of home equity to tap, and b) you need funds for a big, one-time project. 

A home equity loan “is dispersed as a single payment upfront. It’s similar to a second mortgage,” says Bruce Ailion, Realtor and real estate attorney.

With a home equity loan, your home is used as collateral. That means similar to a mortgage, lenders can offer lower rates because the loan is secured against the property. Plus: 

  • Home equity loan interest rates are usually fixed 
  • Loan terms can last from five to 30 years
  • You may be able to borrow up to 100 percent of your home’s value 

The low, fixed interest rate makes a home equity loan a good option if you need to borrow a large sum. And you’ll likely pay closing costs on this loan. So the amount you’re borrowing needs to make the added cost worth it. 

As an added bonus, “a home equity loan or HELOC may also be tax-deductible,” says Doug Leever with Tropical Financial Credit Union. “Check with your CPA or tax advisor to be sure.”

4. HELOC (home equity line of credit) 

You could also finance home improvements using a home equity line of credit or “HELOC.” A HELOC is different than a home equity loan. It functions more like a credit card. You can borrow from it up to a pre-approved limit, pay it back, and borrow from it again. 

Another difference between home equity loans and HELOCs is that HELOC interest rates are adjustable — they can rise and fall over the loan term. 

But, interest is only due on your outstanding HELOC balance, which could be much lower than the full pre-approved amount. With a home equity loan, you’re paying interest on the full loan amount because it’s all taken out at once. 

Because of these differences, a HELOC might be a better option than a home equity loan if you have a few less expensive or longer-term projects that you’ll need to finance on an ongoing basis. 

Other things to note about home equity lines of credit include: 

  • Your credit score, income, and home’s value will determine your spending limit
  • HELOCs come with a set loan term, usually between 5 and 20 years
  • Your interest rate and loan terms can vary over that time period
  • Closing costs are minimal to none

And, by the end of the term, “The loan must be paid in full. Or the HELOC can convert to an amortizing loan,” says Ailion. 

“Note that the lender can be permitted to change the terms over the loan’s life. This can reduce the amount you’re able to borrow if, for instance, your credit goes down.”

Still, “HELOCs offer flexibility. You don’t have to pull money out until you need it. And the credit line is available for up to 10 years,” Leever says.

5. Personal loan

If you don’t have tons of equity to borrow from, a personal loan is another way to finance home improvements.

A personal loan is an unsecured loan, meaning you don’t have to use your home as collateral. These loans can be obtained much faster than HELOCs or home equity lines of credit.

The interest rate on a personal loan can be fixed or variable. And it’s often much higher than for a home equity-type loan. That said, a better credit score will give you a shot at getting a lower rate. 

Also, the payback period for a personal loan is less flexible: often it’s two to five years. And you’ll probably pay closing costs.

Those terms might not sound all that favorable. But personal loans are a lot more accessible than HELOCs or home equity loans for some. 

If you don’t have much equity in your home to borrow from, a personal loan can be a great way to pay for home renovations.

Check your eligibility for a personal loan up to $100,000* (Apr 3rd, 2020)

*TheMortgageReports and/or our partners are currently unable to service the following states – MA, NV

6. Credit cards

You can always charge some or all of your remodeling costs using plastic. This is the quickest and simplest way to fund your project. After all, no paperwork is involved.

But because home improvements often cost tens of thousands, you need to be approved for a high credit limit. Or, you’ll need to use two or more credit cards. Plus, the interest rates charged by most credit cards are among the highest you’ll pay anywhere.

If you must use a credit card to fund your renovations, try this: Apply for a card with a zero percent introductory rate. Some cards offer up to 18 months to pay back the balance at that rate. This approach is only worthwhile if you can pay off your debt within that time span.

Home improvement loans FAQ

What type of loan is best for home improvements?

The best type of loan for home improvements depends on your finances. If you have a lot of equity in your home, a HELOC or home equity loan might be best. Or, you might use a cash-out refinance for home improvements if you can also lower your interest rate or shorten your current loan term. Those without equity or refinance options might use a personal loan or credit cards to fund home improvements instead. 

Should I get a personal loan for home improvements?

That depends. We’d recommend looking at your options for a refinance or home equity-based loan before using a personal loan for home improvements. That’s because interest rates on personal loans are often much higher. But if you don’t have a lot of equity to borrow from, using a personal loan for home improvements might be the right move. You can compare personal loan options here.

What credit score is needed for a home improvement loan?

The credit score needed for a home improvement loan depends on the loan type. With an FHA 203(k) rehab loan, you likely need a 620 credit score or higher. Cash-out refinancing typically requires at least 620. If you use a HELOC or home equity loan for home improvements, you’ll need a FICO score of 660-700 or higher. For a personal loan or credit card, aim for a score in the low- to-mid 700s. These have higher interest rates than home improvement loans, but a higher credit score will help lower your rate.

What is the average interest rate on a home improvement loan?

Interest rates for home improvement loans vary a lot. If you use a cash-out refinance or FHA 203(k) loan, your interest rate might be as low as 3.625% (3.625% APR) (today’s lowest reported mortgage rate on The Mortgage Reports). Average interest rates for other types of home improvement loans, like home equity loans and HELOCs, are higher than mortgage rates. And with a HELOC your rate is variable, so it can rise and fall throughout the loan term.

What is the best renovation loan?

If you’re buying a fixer upper or renovating an older home, the best renovation loan might be the FHA 203(k). The 203(k) rehab loan lets you finance (or refinance) the home and renovation costs into a single loan, so you avoid paying double closing costs and interest rates. If your home is newer or higher-value, the best renovation loan is often a cash-out refinance. This lets you tap the equity in your current home — and you could refinance into a lower mortgage rate at the same time.

Is a home improvement loan tax deductible?

Home improvement loans are generally not tax-deductible. However, if you finance your home improvement using a refinance or home equity loan, some of the costs might be tax-deductible. See our complete guide to mortgage tax deductions for more.

Shop around for your home renovation loan 

As with anything in life, it pays to assess different loan options. So don’t just settle on the first loan offer you find. Compare loan types, rates and terms carefully.

“Get multiple quotes,” suggests Ailion. “And compare the annual percentage rate (APR). Different lenders may be willing to lend you more than others.”

Verify your new rate (Apr 3rd, 2020)

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