Aimée Bennett 
Key Takeaways
- Home improvement loans let homeowners use the funds for any purpose, including home improvements, maintenance and repair.
- There are several types of loans to help pay for home improvements, including personal loans, home equity loans, home equity lines of credit, cash-out refinances and contractor loans.
- Alternatives to loans with monthly payments do exist to fund home improvement projects – including a home equity agreement.
Owners of every type and size of house often want to make improvements to their homes. It might be to increase comfort, boost functionality, improve energy efficiency, address safety issues or personalize a space. Whether you’re looking to remodel a kitchen, upgrade a deck, add a room or make some needed repairs, you’re likely also looking at how you’ll pay for the project. A home improvement loan is one possibility. In this article, we’ll explain what loan options you have and how each works. We’ll also explore other options for financing home improvements.
Understanding Home Improvement Loans
A home improvement loan is simply a loan a homeowner uses to pay for home improvements. Many types of loans exist. Some are dependent on how much home equity you have; some are not. Here’s a summary of loan options that come with a monthly payment.
- Personal loan: A personal loan is typically an unsecured loan, which means it is not tied to an asset. Rather, lenders issue personal loans based on a borrower’s credit profile. They’ll also look at debt-to-income (DTI) ratio to help assess how well the prospective borrower will manage a loan.
Borrowers must repay the amount borrowed – with interest, over a designated period of time, usually between 12 and 60 months. Rates can range from 7% to 36% – or even higher. They will vary by lender and are highly dependent on credit score. Most lenders also charge origination fees, which can range from 1% to 10% of the amount borrowed. There also may be late fees and prepayment fees (if you pay the loan off early).
Banks, credit unions and independent lenders all offer personal loans, typically up to $50,000, although some have higher limits. Some lenders may call these loans “home improvement loans,” given their popular use for these projects, but in almost all cases, they are simply personal loans. Each lender is different, so it’s important to understand all costs involved before making a decision to obtain a personal loan for your home improvement project.
- Home equity loan (HEL): Homeowners with enough equity in their homes may be able to fund their home improvement projects through a home equity loan. With this option, you’ll receive the full loan amount up front. You’ll pay it back in monthly payments that do not change, because a HEL has a fixed interest rate.
Depending on the lender, you can usually borrow 80-85% of your home’s value, minus what you owe on it. An HEL uses your home as collateral, so if you miss payments, you risk foreclosure and losing your home.
Qualification is based on your credit profile and DTI ratio, as well as your loan-to-value (LTV) ratio. That’s the cost of your mortgage (and any other debts on the home) divided by your home’s current value. Again, every lender has its own qualification criteria.
- Home equity line of credit (HELOC): Another option for homeowners with substantial home equity is a HELOC. This option lets you draw money as you need, up to the limit the lender has set. Interest is typically variable, although some fixed-rate HELOCs are available. You’ll pay interest on the amount drawn. And, like an HEL, you can usually borrow 80-85% of your home’s value, less what you owe on it.
A HELOC also uses your home as collateral. Qualification criteria are the same as with a HEL.
- Cash-out refinance: This involves taking out a new mortgage in an amount greater than the remaining principal on your existing mortgage. With the proceeds, you pay off the existing mortgage and take the balance in cash at closing. You then make payments on the new mortgage every month. You can usually borrow up to 80% of your home’s value, less what you owe on the property.
A cash-out refinance usually makes most sense when the rate on the new mortgage is quite a bit lower than the existing mortgage rate – making it a poor option for the many homeowners with low rates they want to keep.
Qualification is based on your credit, your DTI ratio, and your home’s LTV ratio.
- Contractor loan: Some large contracting businesses may offer “home improvement loans” to prospective customers. Generally working with third-party lenders that offer unsecured personal loans, the contractor maintains a relationship with the lender to refer customers.
Qualification criteria mirror those for a personal loan. In some cases, the contracting business may subsidize the loan, effectively lowering the interest rate. While it can be convenient to obtain a loan from the business doing the work on your home, it may also present a conflict of interest. Homeowners could also feel pressure from the contracting business to use their financing.
- FHA Title 1 property improvement loan: The Federal Housing Administration (FHA) offers loans for qualified borrowers to use for designated improvements to their homes. These include buying new appliances, making a home more accessible and improving energy efficiency. The loans, which have a limit of $25,000, do not require the borrower to have equity in their home, but do use the home as collateral for amounts above $7,500.
These loans are provided through private, FHA-approved lenders (such as banks, credit unions, and mortgage companies). The U.S. Department of Housing and Urban Development has a Lender List Search to find approved lenders in your state.
Funding Your Home Improvement Project Without a Monthly Payment
If you are looking for a way to fund your home improvement without taking on another monthly payment, you have a few options.
- Reverse mortgage: If you are age 62 or older, you may qualify for a reverse mortgage. With this option, the lender pays you instead of making monthly payments to the lender. As a result, over time, the lender will own more and more of your home.
In a reverse mortgage, you maintain the title to your home unless you sell, fall behind on insurance payments or property taxes, let the home fall into disrepair, move out for over a year (even involuntarily due to a medical need) or pass away. When one of these things happens, the lender typically will sell the home and collect the cash it lent to the homeowner, along with any outstanding fees. Any remaining equity will pass to the designated beneficiaries. In the meantime, you can use the payments you receive as you wish – including home improvement projects.
- Home repair grants: These grants are offered from governments (federal, state, local) or nonprofit organizations to low-income homeowners. The grants are to be used exclusively for essential repairs, safety upgrades, and accessibility modifications. While they typically do not require repayment, they have strict income and location rules and are competitive to obtain. One example is the U.S. Department of Agriculture’s Section 504 program, which offers grants to homeowners age 62 and older, living in rural areas, to address health and safety issues.
- Home equity agreement (HEA): A home equity agreement provides a flexible, straightforward way to access your home equity without taking on a monthly payment or replacing your existing mortgage. Qualification criteria are less stringent than with traditional loan options and you can use the funds for whatever purpose you have in mind – including maintenance and repair projects, and home improvements.
HEAs allow homeowners to receive cash up front in exchange for a portion of the future value of their home. With Unlock’s HEA, you can buy back your equity at any time during the 10-year agreement term. For many people, that happens when they sell their home.
Evaluating Your Home Improvement Financing Options
Making the decision on how you’ll pay for your home improvement project can be challenging – and worth taking time to evaluate.
If you are considering a loan, you’ll want to carefully review your financial situation and compare loan improvement interest rates and terms for each option. For options that involve a monthly payment, examine your budget and determine how another debt obligation might impact your finances.
Many online calculators are available to help you review payments with different rates and terms. These home improvement loan calculators can be valuable tools for ensuring you understand the total cost and monthly payment of any loan option you are considering.
If you’d rather avoid a monthly payment, an HEA or reverse mortgage might be a better fit.
Beyond cost, you’ll also want to look at the qualifications and conditions required for any option you’re considering.
If you’re self-employed, it can be challenging to meet the income requirements for a home equity loan or cash-out refinance. A HEA, in contrast, has no income criteria to qualify.
A HEL or HELOC may also not be your first choice if you’re not comfortable using your home as collateral.
And if you’re not keen on giving up some of your equity to fund home improvements, an HEA may not work for you. Some HEA providers do offer homeowners who make improvements an adjustment provision. Unlock’s Improvement Adjustment assures that homeowners maintain value created through home improvements they’ve made at their expense. The Improvement Adjustment can reduce your ending home value – thereby reducing the share of proceeds you’ll need to pay Unlock when it comes time to end your HEA.
Maximizing Your Budget With Home Improvement Loans
Creating a plan for your improvements will go a long way toward saving you time and money and reducing stress. To maximize your budget – and time – for your projects, follow these steps.
- Prioritize tasks and projects. Any needed repairs should top the list, followed by routine maintenance items. Then you can add home improvements – major or minor – you want to undertake.
- Estimate. Estimating costs will require you to decide whether you’ll tackle the project yourself or hire a professional. For small repairs or maintenance projects, do-it-yourself (DIY) may make sense. You’ll need to consider the type and size of the project, the complexity and the time involved. You’ll also need to make a realistic assessment of the skills and knowledge required to complete each task.
- Include a contingency fund. Don’t be caught off guard if an unexpected issue arises and threatens to derail your budget. Talk with your contractor about potential cost overruns and reserve an amount between 10% and 30% of your total project for those last-minute expenses.
Conclusion
Deciding to undertake a home improvement project is an important part of homeownership, worthy of careful consideration and planning. Whether you choose a home improvement loan or an alternative financing option, take time to review the pros and cons of each.
