What is a home improvement loan?

Key takeaways

• Home improvement loans come in multiple forms, including personal loans, home equity loans and government-backed loans.

• Home improvement loans are best for individuals who have good credit scores and those who know the return-on-investment of their project.

• Home improvement loans come in both secured and unsecured forms.

A home improvement loan is a type of personal loan specifically designed to fund emergency home repairs, and home improvement or renovation projects. These may include anything from fixing a leaky roof to a full kitchen remodel.

Home improvement loans usually carry lower rates than credit cards and come with fixed repayment terms and interest rates, making monthly payments more predictable.

How does a home improvement loan work?

Whether you opt for an unsecured or secured home improvement loan, they essentially work the same. You get a lump sum, which is repaid over a set period of time with a fixed interest rate. These funds can be used to pay for permits, contractors, equipment, materials and labor needed to complete the work. This can be done for one big project or piecemeal if you are tackling multiple smaller projects.

No matter how long it takes to complete the home improvement, you will begin making monthly payments immediately. The exact amount you pay will depend on how much you borrowed and your rate. When selecting a loan, ensure you have the room in your budget to comfortably make monthly payments — and cover any unexpected costs that may crop up during the renovation process.

Types of home improvement loans

There are five main options when it comes to borrowing money for home projects:

Personal loans

These loans are typically unsecured, meaning they use your credit score and income to determine your eligibility. Because of this, personal loans tend to have higher interest rates than other financing options. Still, you could get an interest rate as low as 4.6 percent if you have a stable source of income and excellent credit. Personal loans are a great option for those with a budget for their home improvement projects, as these are taken out for a specific amount.

Home equity line of credit (HELOC)

HELOCs use your home equity as collateral for the loan — which means you may lose your home if you land in default. Aside from this risk, they provide the same spend-on-the-go flexibility as credit cards, with a much lower interest rate. HELOCs are best suited for those with an ongoing home project that don’t have a set budget.

Home equity loan

Just like HELOCs, home equity loans also use your home equity as collateral. And like a personal loan, you borrow a lump sum and pay it back in even installments. But they tend to have lower rates because they are secured by your home. Home equity loans are an ideal solution if you have less-than-perfect credit and don’t qualify for a low rate with an unsecured loan.

Cash-out refinance

A cash-out refinance consists of replacing your mortgage with a new one that lets you tap into your equity. For these types of loans, you’ll need to have at least 20 percent equity in your home. These are best suited for extensive home renovations.

Government loans

The U.S. Department of Housing and Urban Development (HUD) offers a type of loan known as Title I Property Improvement Loan, which can help you renovate your home for very little if you meet the eligibility requirements. These loans can also be used with a 203(k) Rehabilitation Mortgage, another government loan that allows eligible homeowners to roll up to $35,000 into their mortgage for renovations or home improvement projects.

Should you get a home improvement loan?

A home improvement loan is a good fit if you have a larger project with multiple costs, like a kitchen remodel remodel. A weekend DIY that costs less than $1,000 is better covered by savings or a low-interest credit card.

If you have a good credit score and are offered a decent rate (that’s lower than a credit card rate), then a home improvement loan may be the way to go. However, if your score could use a bit of improvement, it may be best to wait if you can and build your credit so you can score a lower rate.

You should avoid a loan if your budget is already tight. Even loans with low interest rates can be costly, and you need to ensure you will be able to repay to keep your credit score intact. Also, calculate the project’s projected return-on-investment before applying to determine if taking out a loan will be worth it.

The bottom line

Home improvement loans are a key way to fund big projects. While they aren’t good for every homeowner, they can be a solid tool if you know your budget and have good credit.

Start by comparing lenders and looking into what your current bank offers. You may be able to find a good deal — just be prepared to research and provide details on how you will use your loan to upgrade your living spaces.