6 Best Loan Options for Your Home Improvement Project

by Tiffany Wagner

Many people think saving and paying cash for home improvement projects is the only option, or at least the best. After all, there's no interest when you pay with cash. However, some home improvements may come as emergency repairs, making waiting to save enough money to fix a leaking roof or rotting ceiling for months cost you more! Making necessary improvements to keep your house livable makes more sense than moving out, even if it means applying for a loan. 

That being said, we're going to tackle the available home improvement loan options to help you decide which one is the most suitable for you. 

1. Personal Loans

Applying for a personal loan is an excellent alternative to using the equity of your home for funding and using your home as collateral. Collateral is not necessary to qualify; you'll just need  a good to excellent credit score to get the best rates.

Know that a personal loan usually has a higher interest rate compared to home equity financing. It also has a shorter window for repayment - only five to seven years, depending on the lender. A short repayment timeline means your monthly payments will be higher.

If you're making minor cosmetic improvements or installing sprinklers, a personal loan might be the right fit. It's great for borrowers who don't have much equity in their home but have good credit scores or prefer a shorter period for repayment.

2. Installment Loans

This type of loan allows an individual to borrow a large sum of money they can afford to repay over time. An installment loan typically has a fixed interest rate and demands regular payment every month. It can be either secured or unsecured.

Prospective borrowers need to have  a robust credit history to receive the best terms for an installment loan, especially if it’s unsecured. Also, due to the lack of collateral, the interest rate required for a secured installment loan is usually higher, even for well-qualified borrowers.

3. Mortgage Refinance and Cash-Out Refinance

A mortgage refinance is an excellent choice, especially if you funded your home a few years back and the interest rate is relatively high compared to present market rates. It could minimize your interest rate and monthly payments, all of which could free up cash for your renovation project. 

Apart from a mortgage refinance, you might want to consider a cash-out refinance to utilize a portion of your home's equity. In general, lenders will allow you to borrow enough to take out more cash and pay off your current mortgage; this usually amounts to 80% of your home's total value.

You need to think carefully before going with this type of refinance. You’ll need to finance short-term costs with long-term debt and use your home as collateral for a bigger loan. 

A cash-out refinance, in most cases, is only the best option for extensive renovation projects and other improvements and repairs that will increase your home's value.

4. Home Equity Line of Credit (HELOC)

Home Equity Line of Credit, or HELOC, is another option for borrowing money against the value of your home. This option grants you a line of credit equal to 80% of your home’s value minus the amount of your home loan. This does not cover the original mortgage.

HELOCs also come with a repayment period and draw period. In the repayment method, which lasts for about 15 years, expect your monthly payments to be higher, as payments will include more principal.

You can spend the money in your credit line while you're in the draw period, which generally lasts for about ten years. Your monthly payments will cover a little bit of the principal on any outstanding balance and, of course, the interest. 

5. Home Equity Loan

One way to use your equity without the need for refinancing is through a home equity loan. This is similar to a HELOC, however, you will get a lump sum of money rather than a line of credit. It’s an ideal option to get your renovation plans rolling and is best suited for big renovations.

If you don't want to refinance your first mortgage with a very low interest rate, a home equity loan is a sensible option. However, the interest rate for a second mortgage would probably be higher compared to a cash-out refinance.

6. Government Programs

If you have limited equity or credit issues, a loan program from the government may help fund your home renovation project. You can ask your loan originator, bank, or credit union if they're affiliated with these programs.

  • FHA (Federal Housing Administration) Title I Loan - This type of loan will lend you up to $25,000 regardless of your home equity. You could get up to $7,500 for a manufactured home that is your personal property. For this loan option, luxury upgrades are not allowed. The borrower must use the funds only for permanent improvements.
  • FHA Cash-out Refinancing - Unlike FHA Title I, this loan can be used however you want, including non-essential or luxury upgrades. To qualify, you'll need sufficient equity, along with a maximum 85% LTV (loan-to-value ratio), which is lower than other FHA loans.
  • VA Cash-out Refinancing - This loan allows 100% LTVs without mortgage insurance. 
  • FHA 203k - This option is ideal for funding and refinancing improvements. It allows you to go as high as 85% LTV. The only snag is that FHA will set limits on who can do the work and how you will utilize the money.

It's possible to borrow without home equity, but it's risky. You could go into more debt than your home is worth, making selling painful if those improvements don't pay off. 

No matter what type of lender you want to work with and the type of loan you're considering, it's good to shop around for loan options that will help you get the best terms and rates for your home improvement project.

About the Author

Tiffany Wagner is a full time content writer that contributes articles with varying topics. She usually talks about real estate, finance, banking, and travelling. She spends most of her free time playing different kinds of board games, like scrabble and word factory. She is currently honing her skills in chess.