How Do Loan Improvement Loans Work?

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A home improvement loan refers to a way to use a loan rather than a type of loan, as you can use any number of loan types to finance the improvements.

You might take out a home equity loan or line of credit that uses your home as collateral, for example, or an unsecured personal loan that requires no collateral. Whichever type you use, you’ll make monthly payments on the amount you borrowed, plus interest.

What Is a Home Improvement Loan?

Home improvement loans provide a way to pay for upgrades, renovations or repairs to your home. You borrow the amount you need to complete the work, then repay it via monthly payments.

Pros and Cons of Home Improvement Loans

Home improvement loans have several potential benefits, but it’s important to consider the drawbacks as well.

Pros:

• Might improve home value
• Fixed monthly payments, in most cases
• Multiple loan types to choose from

Cons:

• Adds to your debt
• Might require home equity
• Loan interest adds to project costs

Types of Home Improvement Loans

You can use any of the following loan types to finance your home improvements. Consider how suitable each one is for factors like:

• The size and scope of your project
• Your credit and other loan eligibility criteria
• How much equity you have
• Whether you’re willing to use your home as collateral
• Your long-term financial goals

Personal Loans for Home Improvement

A personal loan is usually unsecured, meaning you don’t need collateral. Most have fixed rates, so your interest rate and monthly payment stay the same for the entire loan term.

Personal loan rates are often higher than rates for secured loans. However, you don’t need home equity, so the amount you can borrow is limited only by the lender’s limits and your own credit, income and existing debt.

Personal loans make sense for smaller projects because you can borrow as little as $1,000. Many personal loans offer same-day approval, and funding within a business day or two.

Home Equity Loans

Home equity loans let you borrow against the equity in your home. Your home serves as collateral for the loan, and most lenders allow you to borrow no more than 80% or 85% of your equity in total, including any existing mortgage or home equity loans.

Home equity loans pay out your loan in one lump sum, just like personal loans do. Like personal loans, home equity loans usually have fixed rates. However, loan terms are potentially much longer — as long as 30 years.

Home Equity Lines of Credit (HELOC)

A home equity line of credit, or HELOC, gives you a revolving line of credit, similar to a credit card, instead of a lump-sum payment. Your home secures the loan.

HELOCs often have 15-to-30-year terms. Your credit line remains open during the first five to 10 years, which is the draw period. During the draw period, you usually make interest-only payments on the amount you’ve borrowed. However, you can repay that amount to restore your credit line and then reuse it, just like you might with a credit card.

The repayment period, usually lasting 10 to 20 years, begins after the draw period ends. Rates are usually adjustable, so your rate and payment can change over time, although some loans allow you to lock some or all of your balance into a fixed rate.

Keep in mind that lenders often quote promotional introductory rates for HELOCs. The standard rate could be higher.

Cash-Out Refinance

A cash-out refinance is a new first mortgage you take out for more than you owe on your existing mortgage loan. After repaying your existing loan, you can use the remaining funds for home improvements.

It’s important to note that your new rate could be higher or lower than the rate for your existing loan. Because you pay most of your interest in the early years of a loan, when the principal balance is highest, you’ll lose any headway you’ve made in tipping that balance with your existing loan.

The refi loan is subject to the same rules as your existing mortgage. For example, you’ll have to pay mortgage insurance if you borrow more than 80% of the home’s value, and you’ll have the same kinds of closing costs you had with your existing loan.

FHA Title I Property Improvement Loans

An FHA Title I property improvement loan lets homeowners with limited equity finance the cost of improving their properties. Although the loans are insured by the Federal Housing Administration, they’re issued through approved private lenders.

You can do the work yourself and finance the materials only, or hire a contractor and use the loan for materials and labor both. The maximum loan amount for a single-family home is $25,000, and you can take up to 20 years and 32 days to repay it with a fixed rate of interest. Loans for $7,500 or less have no collateral requirements.

How To Qualify and Apply for a Home Improvement Loan

Qualifications and application processes vary by lender and loan type, with secured loans — cash-out refinance loans in particular — requiring the most documentation.

Here are the basic requirements for home improvement loans:

• Good credit score (usually 620 or better for the best rates)
• Proof of income and employment
• Low debt-to-income ratio
• Home equity, for secured loans

After comparing loans and rates and choosing the loan want, you’ll fill out an application online, by phone or, if it’s a local lender, in person. Online applications have instructions and often, a number to call for support. If you apply by phone or in person, the loan representative will walk you through the process.

Comparison Table: Loan Types for Home Improvements

Here’s a side-by-side look at the different types of home improvement loans.

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