Home Improvement Finance

How Does a Home Improvement Loan Work?

Sick of staring at that 30-year-old formica countertop? Are you planning to make major improvements to your home to increase the value of it? Home improvements — from major projects, like a large addition, to small jobs, like replacing the fridge — can be a considerable investment, and they may not be something for which you have cash on hand.

Here’s everything you need to know about how home improvement loans work.

Types of home improvement loans

Homeowners have a variety of options for financing their remodels. The Federal Housing Administration (FHA) offers two programs for homeowners who wish to remodel: Title I Home and Property Improvement Loans and 203(k) Rehabilitation Mortgage Insurance.

The federal government guarantees borrowers in these programs to make homeownership available to more Americans. While Title I loans may be used to finance large and small home improvements, 203(k) mortgages are typically used for larger scale remodels that are financed in conjunction with the home itself.

Newer homeowners who want to make improvements to their home but have not yet built up significant equity in their home may benefit from a personal loan.

You must meet certain qualifications and work with approved lenders to qualify for these loans. If you do not qualify for (or choose to forego) government-backed home improvement loans, you may take out a personal loan for home improvement with the lender of you choice.

These loans are often called an “unsecured home improvement loan,” as your home is not used as collateral for these loans. Lucia VIllar, GM Head of Personal Loans at Earnest explains, “Newer homeowners who want to make improvements to their home but have not yet built up significant equity in their home may benefit from a personal loan.” Additionally, “A personal loan application is typically far less complex.”

Aside from unsecured personal loans, there are some other ways to finance home improvements (such as a home equity line of credit, construction loan, or mortgage refinance), which we will further discuss below.

Where to get a home improvement loan

Personal loans for home improvement are available from a range of lenders, from traditional banks and credit unions to newer online lenders. Both have pros and cons. For example, banks and credit unions may finance larger remodels and offer competitive rates. If you prefer hands-on service, you’ll also appreciate being able to meet in person and discuss your loan with a representative.

Online lenders, though, have made the loan process quicker and easier than traditional lenders. You could also qualify to borrow more from non-traditional lenders. For example, “Unlike most lenders, Earnest takes a holistic approach to reviewing every application,” says Villar.

Villar adds,”This means that we look beyond the credit score to consider factors such as cash flow, debt-to-income ratio, retirement contributions, savings habits, and education and employment history to get a full picture of your personal finances.” Other lenders to consider are GreenSky, Upgrade, and SoFi.

Depending on the lender, you may or may not have to provide a detailed explanation of the home improvements you plan to do and a quote for the work involved.   Depending on the terms of the loan, payouts could be made in a single cash payment to you upfront (having cash in hand may help you get a better rate from contractors, says Villar) or paid out in installments over the course of the work.

Different personal loans also come with different rates, fees and requirements, so check out what the best personal loans are to ensure that you choose the best option for you.

These are all factors to consider before choosing a lender.

Compare personal loans

Unsecured vs. secured home improvement loans

In addition to unsecured personal loans, you can also finance home improvements through mortgage refinancing, a home equity loan or line of credit, or a construction loan. Refinancing is a good option if it makes sense to refinance your home anyway, while a construction loan really only makes sense for the largest of rehab jobs.

All of these loans use your home as collateral and may involve more paperwork than a personal loan. However, if you have the equity in your home and qualify to take advantage of a secured loan, you may receive a far better annual percentage rate (APR) than you would for an unsecured loan.

Compare home loans

Before you take out your loan

There are a few more important steps to take before applying for your loan.

1) Determine the scope of work

“We’d encourage anyone pursuing home improvement to do their research on which types of home improvements are in demand for buyers in their specific market,” says Villar. “If, on the other hand, this is simply about creating a home that you love and enjoy, recognize that this may be less about the investment, and more about the joy of your upgraded nest.

2) Get several quotes

“[Home improvement projects] are notorious for running late and exceeding the initial budget estimate,” says Villar. Consider basing your loan amount on the higher end of the estimates and/or holding part of the loan amount in reserve in case things cost more than expected.

3) Consider your timeline

Take a look at your budget and be sure you’re prepared to pay back your loan. Personal loans for home improvements may have a far shorter repayment period. Don’t forget that these projects often take longer than expected, so you should count on this if you’re relying on income from your home improvements (e.g. rental income, etc.).

However, you choose to move forward, finding the right lender is the first step to a successful home renovation. “Borrowers should look for quality customer service and lenders that will keep the client’s best financial interests in mind,” says Villar.