Lending institutions offer such a wide range of home improvement financing products that deciding which best serves your purposes can be dizzying. Friends and family members who have secured home improvement loans or leveraged some form of credit often offer their perspectives and advice. But everyday homeowners or prospective home buyers come to the table with unique financial situations and goals. Credit scores, equity, cash-on-hand, and long-term family plans all play a role in the decision-making process. That’s why it’s essential to understand these home improvement financing options before signing on the dotted line.
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How Do Home Improvement Loans Work?
It’s not unusual for people to talk about “home improvement loans” in a generic sense. Discussions typically refer to home improvement loans as being either secured by collateral (your home) or unsecured. These differences demonstrate the wide range of lending products available that can help finance your home improvement projects. Sometimes these types of loans are also called fixer-upper or renovation loans that allow buyers to purchase a home in need of repair for less money but borrow enough to cover the necessary renovations.
Although the term can describe an overall category of loans, it is also a specific loan type that you can consider when looking into financing options. Some credit unions and community banks offer a home improvement loan that is unsecured (like a personal loan) and does not require your home or other assets as collateral. Homeowners prefer this type of loan because it offers a fixed rate that doesn’t fluctuate month to month so it can be easily figured into your monthly budget. This loan also features:
- No risk from using your home as collateral.
- Fast application process.
- Quality home improvement loans come with no closing costs.
- Ability to borrow up to $25,000.
Although this is a great option to pay for your renovation, some homeowners turn away from home improvement loans if they qualify for a secured loan with a lower rate.
When Does A Home Equity Line of Credit (HELOCs) Make Sense?
When you are looking for financing options to help pay for an upcoming renovation, it is worth considering a HELOC. A HELOC is a type of secured home improvement loan that allows property owners to borrow against existing equity in their home. Qualified homeowners establish a line of credit that will enable them to pay for their home improvement project a little bit at a time, withdrawing money when they need it, without having to reapply.
HELOCs are popular because of their borrowing flexibility. Similar to a credit card, you aren’t required to take a one-time lump sum and you only pay interest on the funds you use. HELOCs also allow borrowers increased spending flexibility. This means borrowers can use the money for other things once their home improvement project is complete. They can help pay for an upcoming trip, unplanned emergency, medical bills and more.
Lenders usually look at the following items when qualifying applicants for a HELOC:
- Borrowers debt-to-income ratio at 43 percent or lower.
- The homeowner has a credit score of 620 or higher.
- Established home equity of 10 percent or higher.
Although HELOCs offer a lot of advantages, it is important to keep in mind their adjustable-rate structure would mean varying monthly payments and the calculated risk of your home being used as collateral.
What Makes Home Equity Loans Different?
A home equity loan differs slightly from HELOCs because they usually involve lump-sum borrowing. This type of home improvement financing often offers fixed interest rates rather than adjustable ones offered in a HELOC.
Rather than using funds as you need them during the withdrawal period, homeowners leverage equity and get a single upfront amount. Like the HELOC, this money can finance upgrades, repairs, or be used in discretionary ways, such as paying for medical bills or a child’s college education. Home equity loans remain a popular option because everyday people can roll the fixed monthly installments into family budgets.
How Does Cash-Out Refinancing Work?
This loan product is also popular with homeowners considering home improvements for a variety of reasons. A cash-out refinance loan effectively replaces an existing mortgage and gives the homeowner leftover money to make home improvements.
Qualified borrowers take out a loan amount that covers paying off the existing mortgage as well as the cost of making the necessary or discretionary upgrades. Homeowners often roll closing costs and fees into the cash-out refinancing loan. This type of home improvement refinancing can be uniquely beneficial by offering large loans, low rates, potential tax benefits (ask your accountant for details), and a long repayment period (15 - 30year options are typically available).
Are Credit Cards A Good Home Improvement Financing Option?
Although it’s not unusual for homeowners to leverage credit cards to make upgrades, this strategy needs careful consideration and should be done with extreme caution. Big box home improvement store credit cards may have an appealing zero percent introductory period, but when the no-interest grace period ends, borrowers may regret some of their purchases.
If you are considering paying for home improvements with credit cards, thoroughly vet the product and make sure you can pay the high interest that could accrue. If credit cards are the right solution for your home improvement project, be sure you research all your options, including those at your local credit union or community bank. Ask their lending experts to review your finances and your project budget to ensure it is the most cost-effective solution.
Can You Use Personal Loans To Make Home Improvements?
It would be something of an understatement to say that people view personal loans as go-to financing options. Credit unions and banks have created tremendously diverse products, and qualified borrowers routinely use them as home improvement loans, in the generic sense. Unsecured products generally come with higher rates because lenders take a greater risk. But from the borrower’s perspective, these rank among the proven benefits:
- No risk of using your home as collateral.
- There is typically a fast application process, especially at local institutions.
- Quality personal loans come with relatively low, if any, processing fees.
In many cases, personal loans may offer borrowers significant spending flexibility allowing them to use the money for other purposes. When considering personal loans, look at aspects such as adjustable or fixed rates, monthly payments, and length of the loan. Personal loans, like unsecured home improvement loans, are an excellent option for homeowners who lack equity or need fast funding.
Do Government Loans Fit Your Needs?
Leveraging government loans generally allow qualified people to secure relatively low-interest products. Options such as FHA Title 1 and FHA 203(k) tend to be niche loans and qualifying may prove challenging.
For example, FHA 203(k) renovation loans fall under the fixer-upper category. They allow the homebuyer to finance the purchase of the home and renovation costs all in one loan. Home renovation loans(new blog) of this nature calculate the estimated value after renovations. Going this route can help establish prompt equity and offers more home for the money in many cases, but it also comes with extra due diligence which may require help from professionals. Some requirements of FHA 203(k) loans include:
- Finding a property that would gain enough equity to qualify for a renovation loan.
- Getting pre-approved for a 203(k) loan after being approved for a conventional loan.
- Hiring a certified contractor to provide reliable renovation estimates.
- Supply proof the loan would not exceed the post-renovation value.
- Restrictions on when the money can be accessed (50% upfront to the contractor, 50% in escrow until complete).
- The contractor has six months to complete the work.
- Meet the government qualification requirements.
Securing an FHA 203(k) product can be a Herculean task and may not be worth the low-interest benefits when buying a blighted property.
The FHA Title 1 home improvement financing options can be employed by cash-strapped property owners in dire need of repairs. These HUD-supported products do not necessarily require qualified borrowers to have equity. The primary goal is to ensure low-income families have access to funds that ensure a reasonable quality of life standard.
How to Decide Which Loan is Right for your Home Improvement Project
Selecting from the wide-reaching home improvement loans may seem difficult. But by understanding the way these loan products function and how the long-term repayment plans impact your monthly budget, it’s easier to make informed decisions.
Hard-working people often find that credit unions and community banks offer competitive interest rates and flexible home improvement financing options. Take a moment to finalize your budget, run your numbers through a Home Improvement Loan Calculator to see what your potential monthly payment may be, and always consider speaking with a loan expert at your local credit union or bank to help you find the right solution to fit your needs and budget.
