Home Improvement Loans: A Complete Guide

Owning a home can be a rewarding – and potentially lucrative – endeavor, but it can also be expensive. You see, homes often require maintenance or construction work, which costs money … sometimes a lot of money. That means homeowners often must take out home improvement loans to cover the costs of this work.

What types of loans are out there, and which one is right for you?

What Is A Home Improvement Loan?

When you take out a home improvement loan, you’re using a type of financing that homeowners can use to fund renovations, repairs or upgrades to their property. This allows you to borrow money and pay it back over time, typically with interest.

There are different types of home improvement loans, including secured loans. These require collateral, typically the home itself, which the lender can seize if the borrower fails to make payments. So when you take out a secured loan, you are essentially putting up your home as a guarantee that you will pay it back. Unsecured loans, on the other hand, do not require any collateral but may have higher interest rates and stricter requirements. So this type of loan means there’s not as much risk of you losing your home, but you’ll be paying a higher interest rate in the meantime.

6 Home Improvement Loan Options

There are many different types of loans you can take out to pay for home improvements, and they differ in myriad ways — fees vary, interest rates range and much more. So read on to learn more about your options and determine which type of loan is right for you.

There are also many elements to keep in mind that vary depending on the type of loan you are taking out. They include:

• Origination fees: These are the fees that the lender charges upfront for processing and approving your loan. The amount of the fee is typically a percentage of the total loan amount.
• Eligibility requirements: Lenders examine various factors that determine your eligibility for a loan, including your debt-to-income ratio (how much debt you have compared to your income), as well as your overall income, to determine if you qualify for the loan and what interest rate to charge.
• Repayment terms: These terms refer to how long you have to pay back the loan – 5 years, 10 years, etc. – and what your monthly payments will be.
• Interest rates: Home improvement loans can have fixed or variable interest rates. Fixed rates stay the same over the life of the loan, while variable rates fluctuate over the loan's duration.

Once they are approved for their loan, borrowers typically receive a lump sum deposited into their bank account or are issued a check to fund the home improvement project.

The types of loans that are available for borrowers include:

1. Personal Loans

For many reasons, a personal loan is a popular option for people looking to make improvements to their homes. For starters, you can get the funds from a bank, credit union or online lender pretty quickly, which is critical if you need to make a payment immediately. Also, you can get an unsecured loan (meaning you don’t need to put down your property as collateral). However, the interest rates for personal loans can be much higher than other types of loans, but those vary widely depending on your credit rating.

2. Home Equity Loans

A home equity loan is a secured loan, which means you are putting your property down as collateral. That can make some people uncomfortable, but a home equity loan can be an excellent way to fund home improvement projects as long as you can comfortably afford the payments. The benefits of a home equity loan include the ability to access a large amount of money and lower interest rates because you are using your property as collateral.

3. Cash-Out Refinances

Cash-out refinancing can be an effective and financially savvy way to pay for home renovations or repairs. When you take out a cash-out refinance, it means you are replacing your current mortgage with one that includes equity that has built up in your home and is paid to you at closing. Cash-out refinancing almost always offers the lowest rates of all home improvement loan options.

4. Home Equity Lines of Credit (HELOCs)

A home equity line of credit (or HELOC) allows you to use your home’s equity as a revolving amount of credit – essentially like a credit card. Because the credit is revolving, you can keep drawing on your equity over what’s known as a “draw period.” When that ends, you must start paying back the loan – with interest. This type of loan is especially appropriate for borrowers who don’t have a set amount to borrow or want to lock in an advantageous interest rate. (Note: Rocket Money^SM does not currently offer HELOCs.)

5. FHA 203(k) Rehab Loans

This FHA-backed loan essentially combines the cost of buying a home with the funds needed for renovations and repairs. This loan can be an excellent choice if the house you're looking to purchase or refinance needs major fix-up work, such as fixing safety hazards, overhauling the plumbing or septic system, or installing a new roof and floors. FHA 203(k) loans typically require lower down payments and offer highly competitive interest rates, but the house must be used as a primary residence – in other words, it’s not an investment property.

6. HomeStyle Renovation Loans

When you take out a HomeStyle® Renovation mortgage by Fannie Mae, you can buy or refinance a house and get funds for renovations all in one loan. There are several caveats, however – you must use an approved contractor, and the renovation money is held in escrow and paid directly to the contractor as the work progresses. Because the payments are rolled into your mortgage, it can simplify the renovation process. But it comes with fairly stringent eligibility requirements, such as a high credit score and a low debt-to-income ratio.

7 Ways Homeowners Can Use a Home Improvement Loan

When you own a home, you’ll find that there are many reasons you’ll need a home improvement loan. Sometimes it’s an emergency – a water heater floods, a leaky roof needs to be replaced – or sometimes it’s an upgrade to improve your home and boost its value. These projects can keep your home livable or give you a better living situation in general, and they can also increase your home’s value.

1. Room Renovations

Sometimes a home is still functional but needs upgrades to remain contemporary. Kitchens and bathrooms are prime examples here, as both can become dated and require upkeep or renovation to keep a home from feeling antiquated. New paint and fixtures can only go so far – sometimes, a room needs to be dramatically redone.

2. Yard Makeovers

Many homeowners prefer to keep their outdoors areas pretty for entertaining friends, while others want to have a space where they can enjoy the great outdoors. That’s why some homeowners spend their funds on landscaping, making deck/patio updates, adding new vegetation or adding a pool (or upgrading theirs).

3. Roof Replacement

Unfortunately, roof replacements are also part of owning a home, and getting a new roof needs to be done periodically. There are different types of shingles that are used in these projects -- asphalt shingles are popular and affordable, while metal roofing, such as steel or aluminum, offers superior durability and longevity but is more expensive.

4. Room Additions

Adding a room, such as a bedroom or office, can be beneficial for many reasons, it can give you more room for your family, for instance, while also increasing your home’s value. Also, you can write off some of the tax costs of a home office if you use it for freelance work or have your own business, which can allay the overall cost.

5. Solar Panel Installation

As green energy becomes more popular, more people are investing in solar panel installations to pay for their power. Not only do they provide a green, climate-friendly form of energy, but there are an increasing number of government programs and utility companies offering incentives to switch to sun power. These panels are typically installed on a home’s roof or the top of a property’s other building, such as a garage.

6. HVAC Replacement

Replacing an older HVAC unit with a newer one can be expensive at first, but it can also pay for itself with an energy-saving upgrade that makes it cheaper to operate. Also, newer units are simply better, so they can provide better, more efficient heating and cooling options.

7. New Flooring

New flooring can go a long way when you’re renovating a home – it can provide a modernized feel that dramatically updates a home’s aesthetics, for starters. A new floor can also be easier to clean and maintain, helping to create a better living environment.

At A Glance: Comparing Home Improvement Loan Options

Pros of Home Improvement Loans

While renovating your home can make life more difficult while the work is happening, getting a home improvement loan – and having the work done – can be beneficial for several reasons

Can Increase Home Value

It only stands to reason that newer, more efficient appliances or improved aesthetics can make your home more valuable when it comes time to sell it.

Makes Home Improvements Affordable

Home renovations aren’t cheap, so taking out a home improvement loan can help offset the painful costs that come with this undertaking.

Increases Your Home’s Livability

Home repair work can serve as a reminder that your home still holds beauty and can provide a comfortable, attractive place to live, thereby enhancing your quality of life.

Makes Moving Unnecessary

It can be easy for some to assume that they should just move rather than updating their house. But undergoing a renovation project can end up costing less, and being much less of a hassle, than moving to a new home.

Cons of Home Improvement Loans

Despite these positives, there are also downsides to getting a home improvement loan.

Does Not Guarantee Higher Home Value

While it seems logical that home improvements would create a higher home value, that isn’t necessarily the case. Sometimes, expensive upgrades (such as a pool or converting a garage into living space) might not raise a home’s value as much as the cost, if at all.

Adds More Monthly Payments

If you take out another loan in addition to your mortgage, that means you now have a higher monthly debt. The work may pay off in the long run, but the fact remains that you would be spending more each month.

Makes Foreclosure a Risk

If you take out a secured home improvement loan and don’t adhere to its terms, you could risk foreclosure on your home.

How to Get a Home Improvement Loan in 5 Steps

When you’re undertaking a step as large as a home improvement loan, it’s critical that you do the requisite preliminary work. That includes …

1. Determining Your Home Renovation Project Budget

It’s critical to have a clear idea of your project’s scope before you begin. Get estimates, determine material costs and take every step you can to determine how much the project will cost. Then, objectively assess your financial situation to figure out the most appropriate type of loan for you.

2. Check Your Qualifying Factors

Lenders closely scrutinize your credit score when they are analyzing your ability to repay a loan, so checking your credit report before you begin the process enables you to identify and address any errors or issues. Knowing other financial information, such as your debt-to-income ratio, employment history, income and other factors, will ensure you have a strong command of your loan trustworthiness.

3. Compare Loan Types and Lenders

Do your due diligence to ensure you are pursuing the right type of loan for you, and compare lenders to assess their reliability, interest rates and other important factors.

4. Gather Necessary Documents

Different loans require different documentation, but you’ll need several essential documents to take out home improvement loans. They include:

• proof of identity (such as a driver’s license or passport),
• proof of income for the previous 2 years,
• proof of residence showing you live at the property that is getting the work done
• proof of financial status via bank documents.

5. Apply for the Home Improvement Loan

Once you've done all this work, find the right lender and fill out their application form. After submitting your application, the lender will review your information and let you know their decision. Keep in mind that the lender may request additional documentation before they come to a final conclusion.

Alternatives to Home Remodel Loans

In addition to the loan programs discussed above, there are other financing alternatives that include …

Government Grants and Loans

The federal government offers several loan programs to help homeowners pay for their home improvements.

• Energy-Efficient Mortgages (EEM): These loans are offered by the FHA, Fannie Mae, Freddie Mac and the VA and cover clean energy improvements such as the installation of solar panels, energy-efficient windows and more.
• Title 1 loans: This program, sponsored by the Department of Housing and Urban Development, provides unsecured loans for various home improvements.
• Local programs: Some cities and states provide their own loan programs to help pay for home improvement work. Do your research to determine what loans are available where you live.
• FHA 203(k): Mentioned above

Credit Cards

Some people use credit cards to pay for home improvements, which can come with pros and cons. Some cards have a low interest rate or a 0% introductory APR program, while others offer cashback or rewards on home improvement purchases. But credit cards also have high interest rates that kick in after the promotional rate expires.

Cash

Some people simply don’t like to accumulate debt, so they save enough cash to pay for their home improvement work out of their own pocket. This method helps you avoid accumulating interest, but it also means you might have to live a fairly frugal life for a while, so determine whether the sacrifice is worth it for you and your family.

Home Renovation Loan FAQs

Many common questions arise during the home improvement loan process – they include:

How do I get the best rate for a home improvement loan?

You can start the start the process of getting a good home improvement loan rate by improving your credit score as much as possible before applying. Then, shop around and compare offers from multiple lenders, including banks, credit unions and online lenders. You should also consider getting pre-qualified with several lenders to see their best rates without impacting your credit score. Finally, be prepared to negotiate and ask if lenders can match or beat competitors' offers.

Can I get a home improvement loan with a low credit score?

It is possible to get a home improvement loan if you have a lower credit score, but your options may be more limited. And, you may have to pay higher interest rates or fees. Improving your credit score will allow you to come away with the best rates and loan terms.         

Are home renovation loans tax-deductible?

The interest from cash-out refinances, home equity loans and HELOCS may be tax deductible if you use the money borrowed for home improvements.  

Is a home improvement loan a good idea?

Home improvement loans can be a smart way to finance major renovations or repairs, as they allow you to pay for a project over time rather than all upfront. However, these loans saddle you with additional debt, so you'll want to weigh the benefits of the improvements against the costs you’ll be incurring. For essential upgrades that increase your home’s value or livability, a home improvement loan may be worthwhile if you can afford the monthly payments.

The Bottom Line: Loans For Home Improvements Can Help You Make Upgrades

Renovating your home can be expensive, and there are several options available to help you obtain the funding easily and inexpensively. Improving your home and increasing its value can make your home more enjoyable and more attractive to buyers when you decide to sell, assuming you got the best loan for your home and financial goals. That’s why it’s critical to have a strong command of your finances if you are planning to renovate your home, so start by downloading the Rocket Money^SM app so you can check your credit score before applying for a loan.