Ultimate Guide to Home Improvement Loans

Everything you need to know about paying for home improvements with a loan

Most home improvement projects can increase the value of your home, but they’re also a major pain. Paying to redo the kitchen, install an extra bathroom, or swap out light fixtures gets expensive fast. For example, the average cost of replacing a roof is about $19,000, and some remodeling projects can cost $100,000 or more.

Still, the healthier housing market causing a marked increase in home improvement spending. In 2017, the average homeowner spent $6,649 on home improvements, HomeAdvisor reports. This year, 58% of homeowners increased their budgets for home improvement projects.

And with U.S. disposable income and personal consumption on the rise, home improvement spending grew steadily throughout 2018. The Joint Center for Housing Studies of Harvard University predicts that homeowners will spend $339 billion on remodeling in the first quarter of 2019 alone. That’s 6.9% more than the previous year.

“As more homeowners are enticed to list their properties, we can expect increased remodeling and repair in preparation for sales, coupled with spending by the new owners who are looking to customize their homes to fit their needs,” says Chris Herbert, the center’s managing director.

If you find navigating the convoluted home improvement lending market confusing, here’s the lay of the land.

Considerations

Before you borrow money for your home improvement project, here are some factors you should consider.

  • Know your costs. Get a price estimate on your renovation, broken down by cost of labor, materials, equipment rentals, and permitting. Add a comfortable buffer to account for surprise expenses. If you can’t borrow enough to cover that final figure, scale back your upgrade plans.
  • Figure out your timeline. Don’t take out a loan that requires 12 years to repay while funding improvements that you’ll need to repair in 10. The U.S. Department of Housing and Urban Development (HUD) warns homeowners to “weigh the cost of borrowing against the cost of delaying the work. If you have to borrow, you want to do it in the least expensive way.”
  • Focus on function over flair. Think twice about accepting debt for projects without much practical value, like a new pool. Focus instead on immediate needs, like a faulty heating system, and then finish any incomplete spaces. These will improve your home’s value more than aesthetic updates.
  • Recoup your investment. As a rule, the simpler and lower-cost the project, the larger its cost-value ratio, says real estate data company Hanley Wood. Remodeling efforts this year recouped an average of 72.5% of their investment value when the homes were sold within a year. Keep your renovations simple for higher returns.
  • Consider your limits. How much a lender will offer you depends on your credit score, your debt-to-income ratio, and your income. For home improvement projects, it’s unlikely that you’ll get more than 90% of your home’s value, minus whatever’s still owed on the mortgage.

Loan options

While using your savings is the best way to pay for these projects, it’s not always possible. If you want to make home improvements, but don’t have the extra cash, don’t despair. Home improvement loans are available in many forms. The best choice for a home improvement loan depends on the cost of your project and your financial situation.

Some options to consider include:

  • Unsecured or personal loans
  • Government loans
  • Second mortgages and refinancing
  • Credit cards
  • Home equity loans and home equity lines of credit
  • Green grants and loans

Unsecured or personal loans

Unsecured loans aren’t tied to the borrower’s collateral. This appeals to consumers who haven’t built up much home equity. It’s also compelling if you don’t want to put your entire property on the line just to repair the roof. New homeowners or those who don’t have lots of home equity can take out a personal loan.

You can borrow less than a home equity loan or HELOC requires. If you’re planning on making smaller home improvements, such as installing windows, a personal loan is an excellent way to go. Some lenders offer loans as little as $1,000. Unlike home equity loans, you won’t be at risk of losing your house if you can’t repay the loan on time.

If you need a home improvement loan, consider the most active lenders in the home improvement sector: Greensky, SoFi, LendingClub, and Lightstream. Interested? You can get quotes from all of them with this one simple form.

Government loan programs

If you don’t have the equity necessary to make home improvements, you may qualify for a government loan. Many DIY or contractor-supervised projects fall within this purview, like building a dishwasher into the kitchen framework, widening doors for wheelchair access, alternative energy integration, and more.

Fannie Mae HomeStyle Renovation mortgage (HSR)

This option comes from the Federal National Mortgage Association or Fannie Mae. Fannie Mae doesn’t require a minimum expenditure and doesn’t restrict your renovation options. Whether it’s a functional or cosmetic fix, as long as the improvement is a permanent part of your property and adds value, Fannie Mae will fund it.

Lending caps off at 95% of the home’s appraised value after the upgrades are complete. Also, borrowers will have to make a down payment — at least 5% for those with excellent credit and a single-unit home.

FHA loan programs

The FHA loan programs include the Title 1 program and the 203(k) program. The agency insures Title 1 loans from banks and other approved lenders to fund projects that improve a home’s livability and safety. Title 1 provides loans up to $25,000 for necessary renovations, such as replacing a roof. The FHA 203(k) program helps homeowners finance their mortgage to make repairs or purchase fixer-uppers.

The 203(k) program is the FHA’s version of Fannie Mae’s HSR. It’s more accepting of borrowers who can’t afford a hefty down payment or who have mediocre credit. However, these borrowers will face higher insurance premiums. If your home improvement increases your home’s value, FHA lenders will lend up to 10% more than the current value of your home. Their loans start from $5,000, and the down payment starts at 3.5%. Learn more here.

You’ll have up to 20 years to pay back the loan, and the interest may be tax-deductible. Title 1 loans max out at $25,000 for existing single-family structures, with different limits for mobile and multi-family homes.

Second mortgages and refinancing

If you’ve owned your home for a long time, mortgage refinancing is a practical option. Paying a lower monthly mortgage rate allows you to “cash-out” and use the money you save on home improvement projects. This type of loan is best for home improvement projects that will increase the resale value of your house, such as remodeling your kitchen.

Cash-out refinance

Mortgage rates are fairly low. This makes refinancing an older mortgage tempting. Cash-out refinancing replaces your old mortgage with a larger one (with lower interest rates) and gives you the difference in cash. But there are downsides to this option: high closing costs and higher interest rates than standard refinancing.

Credit cards

If you’re planning to make smaller improvements (costing less than $15,000), you can use a credit card instead of taking out a home loan. However, credit cards carry high interest rates, and you could spend more money paying it off than the project is worth. To avoid this, use credit cards for projects you can quickly pay off.

You should only finance your renovation with credit if your credit is good, your remodeling project is small, and your expenses are payable within a year and a half. If your home improvement project qualifies for these criteria, consider signing up for a new credit card with a 0% introductory offer. This allows you to finance your project interest-free within an allotted time.

But be wary because once the promotional period ends, your interest rates will skyrocket. Also, many contractors don’t accept credit cards, so a loan that allows you to access cash may be preferable. Check out SuperMoney’s recommended list of credit cards here.

Home equity loans (HEL) and home equity lines of credit (HELOC)

You can use the equity in your home to secure both HELs and HELOCs. Your home equity means they have lower interest rates than personal loans or credit cards — often under 5%. Their payback terms are usually long, so they’re well-suited for larger or more frequent projects with budgets over $50,000.

Also, you can deduct interest accrued from a HEL or a HELOC from your taxes. But be sure to make your payments on time. If you default on these loans, your home is on the line.

What’s the difference between a HEL and a HELOC?

If you take out an HEL, you’ll receive a lump sum with fixed interest rates. Most require the principal and interest to be paid back within 15 years, though terms range from five to 30 years.

A HELOC works like a credit card with a revolving open credit line that borrowers can tap as necessary up to a specific point. You only pay interest on the amount you withdraw, but interest rates fluctuate with the market. The timeline usually requires payment after 10 years.

What’s the catch?

Unfortunately, the application process for HELs and HELOCs is not as straightforward as with other sources of credit. Borrowers need to have enough equity in their homes for such a loan to be worthwhile. Also, these loans often come with origination, pre-payment, and closing fees.

Home Equity Loans

Home equity is the difference between the market value of your home and the amount you have left to pay off on your mortgage. It’s an asset that represents the part of the house that you have paid for, and it can increase over time. A home equity loan is similar to a second mortgage. It allows you to borrow against your home equity in exchange for a lump sum of cash.

Borrowers can pay the loan back in fixed monthly installments. According to the IRS, interest on these loans is tax-deductible up to $100,000. Although you can lose your home if you fail to repay the loan, the benefits often outweigh the risks.

Why choose this loan?

The benefits of a home equity loan include:

  • It’s easier to qualify.
  • They have lower interest rates than unsecured loans.
  • These types of loans open up large sums of money for significant home improvement projects.

Home Equity Lines of Credit (HELOC)

Home equity lines of credit (referred to as HELOC) also use your house as collateral but offer more flexibility than a home equity loan. This type of loan is suitable for long-term projects. Instead of receiving a lump sum of cash, you can choose smaller amounts to borrow over a certain period. The amount you’ll pay in interest is lower than other types of loans.

“Remodeling is at an all-time high, and it’s much more efficient to fund that activity with a four percent HELOC than a credit card charging 17% interest,” said Jeff Taylor, managing director of Digital Risk (source).

If you’re unable to pay off the full amount of your monthly installment, you may have options. Many HELOC lenders offer the option to pay off the interest until you’re back on your feet.

Shared equity agreements

Shared equity agreements, also known as a shared appreciation, are a new source of cash available to homeowners. They are financial agreements that allow you to sell a stake in your home’s future equity. It’s important to understand that although they share some similarities, shared equity agreements are not mortgages. In fact, they aren’t technically loans. For this reason, their credit and income requirements are often lower than traditional home financing products.

With shared equity agreements, you won’t have to make any monthly payments on the amount, nor pay any interest. When the term is up, whether triggered by a set number of years or the sale of the home, you’ll repay your investor. How much you pay depends on whether your property’s value went up or down.

Green grants and loans

Do you want to help save the environment by adding solar panels, boosting energy efficiency, or scaling back waste? Some lenders offer loans dedicated to eco-centric projects.

In California, Florida, New York, and Pennsylvania, Renew Financial offers up to $250,000 in financing for green projects. And some nonprofits and government agencies reserve grant money that you don’t need to pay back for the same purpose. DSIRE has a database of state incentives searchable by zip code. The FHA even offers an Energy Efficient Mortgage.

Choosing a lender

You don’t need to go through your mortgage lender, though if you have a good relationship with them, you may get better rates. If customer service is a priority, check out J.D. Power’s mortgage servicer satisfaction survey and reach out to the top performers. Credit unions often offer flexible terms on renovation debt.

If you’d like to pursue a credit union, you can check out some FHA-approved lenders here. For a list of some of Fannie Mae’s most efficient lenders, click here. You have a ton of online lenders to choose from nowadays. These lenders will consider your credit, but many will also take into account factors like your profession and education.

LightStream offers its lowest rates — 4.29% with autopay — for home improvement borrowers with excellent credit and substantial incomes. Be wary of contractors who offer to handle the financing for you. In general, you’ll see better results if you evaluate your options on your own.

Getting started

No matter what type of loan is best for you, finding a lender to work with is critical. Compare the rates of leading lenders for personal loans and home loans. If you’re ready to take the plunge, use our loan engine to get pre-approved loan offers without hurting your credit score.

Are you ready to find the right financing option for you? If you’d like to see what kind of loan terms you qualify for, click here to get quotes from top online lenders. It only takes a minute, and pre-qualifying won’t hurt your credit score.