Are you thinking about making improvements to your home? It’s not a bad idea. In doing so, you can enjoy the renovations now as you live in your home and can recoup some, if not all, of your costs later if you sell your house.
For example, a midrange bathroom addition can add $23,283 to your home’s value while a minor kitchen remodel can add $16,669, according to national averages from Hanley Wood’s 2017 Cost vs. Value Report. The catch? Home improvements do come at a cost which is typically more than homeowners can or want to pay out-of-pocket.
So, let’s look at home improvement financing options along with their advantages and drawbacks to help you identify which one is right for you.
Home equity loan or line of credit
The amount of home equity you have can be found by subtracting the amount you owe on your house from the amount an appraisal says it’s worth. For example, if your home appraises for $450,000 and you owe $200,000, you would have $250,000 worth of home equity.
You can gain access to the equity in your home by taking out a home equity loan or a home equity line of credit (HELOC). The loan or credit line will be secured by your house, which means, if you don’t pay it back, the lender can foreclose your home and sell it to repay your debt.
The benefits include that they are often an easily accessible source of cash if you have equity in your home, interest rates are usually lower than those offered on unsecured loans and the interest you pay is tax-deductible.
What is the difference between a home equity loan and a HELOC?
Home equity loan
A home equity loan enables you to take out your home equity as one lump sum, and the Federal Trade Commission (FTC) says that most lenders allow you to borrow up to 85% of the equity in your home.
As for the costs, these loans typically have a fixed interest rate, which means that you repay the amount over a predetermined period of time with equal monthly payments.
There are usually other costs, as well (i.e. closing costs). Home equity loans are a good option if you need all the money for your renovations up front and if you prefer a predictable monthly payment.
A HELOC is a revolving line of credit, similar in nature to a credit card. Casey Fleming, Author of the The Loan Guide: How to Get the Best Possible Mortgage and mortgage advisor says, “An equity line can be the least expensive option to put in place because you can draw money as you need it, and you don’t have to pay interest on it until you need it.”
The FTC says your credit line may be as much as 85% of your home’s appraised value minus the amount you still owe on your original mortgage. Instead of a fixed interest rate, the HELOC typically has a variable APR, which means your payments will fluctuate.
Terms such as the length of time you can draw from a HELOC, the repayment terms, the costs and how much the interest rate can change within a period of time can vary greatly from one lender to the next. That being so, you will want to shop around and carefully review the offers from different companies.
You can compare lenders that offer both home equity loans and lines of credit on our Home Loans Review Page by ticking the box in the left-hand menu for “Home Equity Loans and Lines of Credit.”
Fleming warns homeowners to be wary of financing through contractors. He says, “Most contractors have relationships with lenders that will offer financing for the project. These lenders are usually very expensive, although they are very convenient. They finance as a second mortgage and thus fall under the equity loan category. Consumers MUST shop and not just take the loan the contractor offers, even if they offer “interest-free for 12 months.”
In summary, these can provide you with a sizeable amount of cash to use towards home improvements at a relatively low interest rate, but will only be accessible if you have equity in your home.
Another option is the cash-out refinance where, instead of getting a second mortgage, you replace your current mortgage with a new and larger one.
For example, if you owe $200,000 and your house appraises for $450,000, you could get a new loan for $300,000, thus paying off your original loan and withdrawing $100,000 of the equity in your home for your home improvements.
The amount you can “cash out” will be based on factors such as the lending institution you choose, your credit score and the equity you have in your home. Fleming says, “You can only take out a certain percentage of your current (home) value – typically 85%.”
Other factors to be aware of with a cash-out refinance include that you can often get a lower interest rate than is available through home equity loans, there will be closing costs and Private Mortgage Insurance (PMI) may be required if you borrow more than 80% of your home’s value.
These loans are attractive because you still only have one mortgage to manage, you can get the money you need and the interest is often low. However, they can have expensive costs, may require PMI and they are secured by your home.
If you’d like to see what kind of deal you can get, you can review and compare cash-out refinance lenders here.
Personal loan or line of credit
A personal loan isn’t secured by any asset, but, instead, is granted based on your credit history. If you need a home improvement loan, consider Greensky, Sofi, LendingClub, and Lightstream, they are among the most active lenders in the home improvement sector. SuperMoney has made it easy to apply with all of them with one simple form via the SuperMoney loan offer engine.
Typically, you will apply and the lender will check your credit. If approved, you will be offered a loan amount or maximum line of credit, repayment period and cost terms. Costs can include fees and interest.
When comparing personal loans to the previous options, Fleming says, “Personal loans aren’t typically secured loans, so they are easier and cheaper to put in place. Partly because the lender doesn’t have to comply with Consumer Financial Protection Bureau (CFPB) and state rules regarding loans on real estate.”
Personal loans aren’t typically secured loans, so they are easier and cheaper to put in place. Parltly because the lender doesn’t have to comply with Consumer Financial Protection Bureau (CFPB) and state rules regarding loans on real estate.”
The downside? “The interest rate on them tends to be very high,” says Fleming. He advises, “If you can get in and out quickly, (meaning get the work done quickly and then refinance and pay off the loan) that might work out well. However, it’s important to be sure that there is no pre-payment penalty on the loan.”
While some personal loans do have high interest rates when compared with secured loans, the rate you are eligible to get will depend on your credit and the lender you choose.
If you’d like to find out what you qualify for with a variety of lenders without hurting your credit score, head over to Supermoney's loan prequalification tool. You will be asked a few quick questions and then will receive offers from a number of companies that are competing for your business.
There are also loans specifically designed for covering the costs of a new home that needs construction as well as refinancing a mortgage and paying for home improvements.
“A construction loan uses the value of the property after the proposed improvements are made, and therefore you can borrow more than your home is currently worth.” says Fleming, “The lender will hire a project manager, who will oversee the payouts to the contractor, so you have a professional who is watching out for your interests in the construction project. However, construction loans are a little more expensive than conventional loans and have fees that conventional loans don’t have.”
“FHA 203K loans fall under the construction loan category.” says Fleming.
This program was created by the FHA and insures mortgage loans, which can be used to refinance an existing mortgage and pull out money for repairs, improvements or to prepare a home to go on the market. The loans are serviced by intermediary lenders and a limited version is available for less extensive repairs (under $35,000).
The funds left over after paying off your original mortgage will be kept in an escrow account, to be released as rehabs are completed. This is a single-close loan with a long term, and lenders must be FHA approved. Find FHA lenders here by ticking the box in the left-hand menu for “FHA”.
Title 1 loan
The U.S. Department of Housing and Urban Development (HUD) has put the Title 1 loan program in place, which insures approved Title 1 lenders against losses on property improvement loans. According to HUD, these loans go up to $25,000 for a single family house and can be used for alterations, repairs and site improvements.
Loans of $7,500 can be unsecured, while those over that amount will be secured by your home. You can search for a lender in your state here.
Get started on your home improvements
Now that you know multiple options you can choose from when it comes to improving your home, it is up to you to weigh the pros and cons and decide which will be best for you. Once you decide on the financing type you want, be sure to shop around and compare the offers you get from multiple lenders to ensure that your home improvements will be as cost-effective as possible. Then, you can get started on making the changes you desire for your home.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.