The Pros and Cons of a Home Improvement Loan and Where to Get One 

Key takeaways: 

• Home improvement loans are personal loans where a homeowner can use the funds for any reason – including home improvements.  
• You can find these loans through banks, credit unions and independent lenders, as well as through some larger contractor firms. 
• Many alternatives to personal loans exist to fund home improvement projects, including several loan-based ones and the no-loan home equity agreement.  

You’ve realized it’s time for that long-delayed kitchen remodel. Or maybe you’d like to install a deck, upgrade your floors or even need a new roof. If you haven’t been saving up for the project, you might have started looking at funding options. You may have found that even a rudimentary Google search on “home improvement loan” is making this option look more complicated than you expected.  

In this article, we’ll clarify what a home improvement loan is, look at the pros and cons, and review alternatives. 

Defining “home improvement loan” 

A home improvement loan is a personal loan where the homeowner chooses to use the funds to pay for home improvements. With most personal loans, you can use the money however you wish. Paying for home improvements is one of the most popular uses for personal loan funds. 

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. You will need to repay the money you borrow over a designated period, generally between 24 and 60 months, with interest. Most lenders charge origination fees of about 2-7% of the amount borrowed. There also may be late fees and prepayment fees (should you choose to pay off the loan early). Each lender is different, so it’s important to understand all costs involved before deciding to obtain a personal loan. 

Qualification 

Personal loans are generally unsecured, meaning they are not tied to a tangible asset, like your house. Qualification for a personal, or home improvement, loan is based on your credit profile. Some lenders will require a certain number of years of credit history, and all will look at credit scores. In general, the higher the applicant’s credit score, the lower the interest rate offered. With many lenders, the minimum credit score for a personal loan is 620, but many will lend to a consumer with lower scores at higher rates. For those without good credit, a co-borrower with very good credit – typically a score above 740 – can be helpful in securing a personal loan.  

Lenders also will look at your debt-to-income ratio to help assess how well you manage debts. A higher ratio can mean a higher risk of not repaying a loan.  

The personal loan qualification process can be very quick. Once you’ve submitted a complete application, approval and funding can happen in as few as three days, depending on the lender. 

Getting a home improvement loan through a contractor 

Today, some larger contracting businesses are offering “home improvement loans” to prospective customers. While this form of financing can be convenient, take time to understand it works. 

These large firms generally work with third parties – lenders – that offer unsecured personal loans. The contractor maintains a relationship with the lender to refer customers. Borrowers must qualify based on their credit profiles, as explained above.  

There can be some benefits to obtaining a personal loan this way. In some cases, a contracting business may subsidize the loan, effectively lowering the interest rate to the customer. Working with contractor financing can save you the time of researching other options, too.  

However, deciding on a loan while an employee of the contracting business is standing in your kitchen, and when you may have just agreed on an estimate for the remodel you want, could make you feel pressured to spend more than you planned, or to start your project before you’re ready.  

Note, too, that these loans are offered through large firms. Smaller contracting businesses, and independent contractors, many of whom can readily take on that kitchen upgrade or other project, generally will not want to offer customer financing. In turn, they may offer better pricing, flexibility and the security that can come with knowing exactly who will be working in your home. 

Getting a loan of any size, and taking on additional debt, is an important financial decision. It’s wise to take some time to research alternatives. 

Other options for home improvement project financing 

Homeowners with enough equity may be able to fund their home improvement projects through a variety of other options.  

Home equity loan (HEL): Homeowners receive the total amount of a home equity loan up front. This loan has a fixed interest rate that will not change over the entire term, so you know your monthly payments will not change. Depending on the lender, you can usually borrow 80-85% of your home’s value, less what you owe on it. An HEL uses your home as collateral, so if you miss payments, you risk foreclosure and losing your home. 

Home equity line of credit (HELOC): A HELOC lets you draw money as you need, up to the limit the lender has set. Like an HEL, it’s a loan, and it uses your home as collateral. Interest is typically variable, although some fixed-rate HELOCs are available. You’ll pay interest on the amount drawn. And, also like an HEL, you can usually borrow 80-85% of your home’s value, less what you owe on it. 

Cash-out refinancing: 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, minus what you owe on it. A cash-out refinance usually makes sense when the rate on the new mortgage is quite a bit lower than on the existing mortgage – making it a poor option for the many homeowners who were able to secure an ultra-low interest rate on their mortgage a few years ago. 

Reverse mortgage (age 62 and up): In a reverse mortgage, the bank pays you instead of you making monthly payments plus interest. As a result, the bank will own more and more of your home. You can maintain the title 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 and any outstanding fees. Any leftover equity will pass on to designated beneficiaries. In the meantime, you can use the payments you receive as you wish – including for home improvement projects. 

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, require use of the home as collateral for amounts above $7,500. 

Home equity agreement (HEA): The HEA provides a way to access your home equity without taking out a loan. Qualification is generally easier than with loan options, income requirements are flexible, and there are no associated monthly payments and no interest rates to worry about. 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.  

Take the next step 

If you’re ready to move ahead with that kitchen remodel, several alternatives to finance the project are available. Take time to review the pros and cons. If you decide you would like to explore how to tap your home equity without a loan, check out the Unlock HEA and see how much equity you could access.