How To Get Home Improvement Loan – Home renovations can be expensive. But the good news is you don’t have to pay out of pocket. A home improvement loan allows you to pay for home upgrades and repairs.
Specialized rehabilitation loans, such as FHA 203(k) mortgages, are designed to finance home improvement projects. There are also second mortgages — home equity loans and HELOCs — that can provide cash for home improvements or any other purpose.
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So, what are the best loans for home improvements? It depends on your needs. Here’s what you should know.
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A Home Equity Loan (HEL) allows you to borrow money against the equity in your home. Your equity is calculated by appraising the value of your home and subtracting the outstanding balance of your existing mortgage.
Unlike a cash-out refinance, a home equity loan doesn’t pay off your existing mortgage. If you already have a mortgage, you’ll continue to make monthly payments while paying off your new home equity loan.
Home equity loans “spread out into a lump sum down payment. It’s similar to a second mortgage,” says Bruce Ailion, a realtor and real estate attorney.
With a home equity loan, your home is used as collateral. This means that lenders can offer lower interest rates because the loan is secured against the property. If you need to borrow a large sum of money, low fixed interest rates make a home equity loan a good choice.
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Keep in mind that you may be charged a closing fee of 2% to 5% of your home equity loan loan balance. So make sure you borrow enough to be worth the added cost.
As an added bonus, “a home equity loan, or HELOC, is also tax-free,” says Doug Leever, member FDIC, of Tropical Financial Credit Union. “Consult your CPA or tax advisor to be sure.”
A home equity line of credit (HELOC) is another great way to borrow against home equity without refinancing. A HELOC is similar to a home equity loan, but works more like a credit card. You can borrow, repay and borrow again up to a pre-approved limit.
Another difference between a home equity loan and a HELOC is that HELOC rates are adjustable; they may rise or fall over the life of the loan. But interest is only paid on your outstanding HELOC balance (the amount you actually borrow), not the entire line of credit.
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You can only borrow a portion of the maximum loan amount at any time, which means your repayments and interest charges will be lower.
If you have some less expensive or long-term remodeling projects that require ongoing financing, a HELOC may be a better option than a home equity loan.
At the end of the term, “the loan must be repaid in full. Or the HELOC can be converted to an amortized loan,” Ailion said. “Be aware that lenders can be allowed to change the terms during the life of the loan. For example, if your credit declines, this can reduce the amount you can borrow.”
Still, “HELOCs offer flexibility. You don’t have to withdraw money when you need it. The line of credit is good for up to 10 years,” says Leever.
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Another popular way to finance home remodeling projects is cash-out refinancing. This option allows you to refinance a new mortgage with a balance greater than what you currently owe. Then you pay off your existing mortgage and keep the remaining cash.
The money you receive from a cash-out refinance comes from your home equity. It can be used to finance home improvement projects, such as finishing a basement or kitchen remodel. However, there are no rules dictating what the funds must be used for.
Cash-out refinancing is often the best home improvement loan when you can lower your mortgage rate and withdraw cash. This feature will only work if the current market rate is lower than your existing rate.
You might also be able to adjust the length of the term to pay off your home loan faster. For example, say you have 20 years remaining on your 30-year loan. Your cash-out refinance could be a 15-year loan, which means you’ll plan to pay off your home loan five years early.
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So how do you know if you should refinance with cash? Start by comparing costs over the life of the loan, including closing costs. That means looking at the total cost of a new loan versus the cost of keeping your current mortgage for life.
Keep in mind that cash-out refinances have higher closing costs, and they apply to the entire loan amount, not just the cash back. Therefore, you may need to find an interest rate that is well below current rates to make this strategy worthwhile.
With the FHA 203(k) plan, you don’t need to apply for two separate loans or pay closing fees twice. Instead, you finance both the purchase and home improvements when you buy a home.
An FHA 203(k) rehab loan is great when you’re buying a home and know you’ll need immediate financing for a home improvement project. These loans are backed by the government, which means you get special benefits like a lower down payment and the ability to apply for a loan with a less than perfect credit profile.
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On the other hand, such loans may take longer to complete. “FHA 203(k) loans can be drawn down, but it’s hard to get approved,” says Jon Meyer, a mortgage reporting loan specialist and licensed MLO. If you choose this route, it’s important to choose a lender and loan officer who are familiar with the 203(k) process.
If you don’t have enough home equity to borrow, a personal loan is another way to finance home improvements.
Since personal loans are unsecured, you won’t be using your home as collateral. That means these loans are available much faster than HELOCs or home equity lines of credit. In some cases, you may be able to get loan funds the next business day or even the same day.
Interest rates on personal loans can be adjustable or fixed, but are usually higher than home equity loans or HELOCs. That said, if you have good credit, or even just good credit, you’re likely to get an affordable rate.
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Personal loans have less flexible repayment periods, usually two to five years. And you may also have to pay closing costs.
Those terms might not sound very favorable. But for some borrowers, a personal loan is more accessible than a HELOC or home equity loan. If you don’t have much equity in your home to pledge against, you can opt for a personal loan to pay for home improvements.
These loans can also be used to finance emergency home repairs if your water heater or HVAC system must be replaced immediately. Still, Meyer warned that a personal loan is the “least sensible” option for homeowners.
You can also use plastic to pay for some or all of your remodel. This is the fastest and easiest financing option for home improvement projects. After all, you don’t even need to complete a loan application.
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But since home renovations often cost tens of thousands of dollars, you’ll need to get approved for a higher line of credit. Or, you need to use two or more credit cards. Plus, you may pay a higher interest rate than you would on a home improvement loan.
If you must use a credit card to pay for renovations, try getting a card with a 0% annual percentage rate (APR). Some cards offer up to 18 months to pay off the balance at an introductory rate. This approach only makes sense if you are able to pay off your debt within the repayment period.
Like personal loans, credit cards are acceptable for emergencies. But you shouldn’t use them for long-term financing. Even if you have to use a credit card as a temporary solution, you can get a secured loan later to pay off the credit card.
The best home improvement loans will suit your specific lifestyle needs and unique circumstances. So let’s narrow down your options with a few questions.
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If so, you can get the lowest rates by borrowing against your home equity with a cash-out refinance, home equity loan, or home equity line of credit.
If so, check out the FHA 203(k) plan. This is the only loan on our list that bundles home improvement costs with the home purchase loan. Just review the guide with your loan officer to make sure you understand the rules for disbursement of funds.
Fulfilling both needs with just one mortgage application will save you on closing costs and is ultimately a simpler process.
“The only time I would recommend the FHA203(k) plan is when buying a permanent home,” Meyer said. “But I still recommend that homeowners explore other loan options.”
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When you need urgent home repairs and don’t have time to apply for a loan, you may have to consider a personal loan or even a credit card.
Keep in mind that these options have significantly higher interest rates than secured loans. so you will want
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