Americans spend a lot of money on home improvement and repairs every year – more than $ 400 billion in 2019, according to Harvard University’s Joint Center for Housing Studies.
And while the pandemic recession is causing people to spend less on home improvement this year, renovating a home is still a great way to add value and make it a better place to live.
That’s especially relevant now as people spend a lot more time indoors during the pandemic.
But the cost of these renovations can add up quickly.
If you’re wondering how to finance a home improvement project, you know there are several options to choose from. Many home improvement projects are funded with a home equity loan or a home equity line of credit (HELOC), but there is a third option: taking out a personal home renovation loan.
Unlike a home equity loan or HELOC, a home improvement personal loan does not require you to pledge your home as collateral. The funds are paid out in advance in a lump sum. However, it will likely have a much higher interest rate than a home equity loan or HELOC and generally have a much shorter repayment period – anywhere from one to five years.
Personal loans are “always a little bit riskier,” says Carol Ann Reed, Realty Group real estate agent in Minnesota. “It’s always better to pay for repairs and renovations with cash rather than borrowing,” says Reed. In the case of expensive home renovations or urgent repairs, this is sometimes not realistic. Here’s what you should know about home improvement financing with a personal loan – and some alternatives to consider.
Should You Get A Home Improvement Personal Loan?
A home equity loan, HELOC, or a cash-out refinance are better options, says Dan Moralez, mortgage officer and regional vice president at Northpointe Bank in Michigan.
“The problem with a personal loan is that you generally pay a higher interest rate and you usually have an expedited repayment period because there is no collateral,” says Moralez. “That’s probably the worst way to finance the home improvement.”
So, when considering the idea of getting a home improvement personal loan, you should consider your priorities and your overall financial situation. Look at how much equity you have in your home, analyze your creditworthiness, determine what interest rates are likely to be available to you given your creditworthiness and general financial condition, and compare secured versus unsecured loans.
Speak to several potential lenders and remember that a personal loan to finance your home improvement project makes the most sense in the following scenarios:
You don’t have a lot of equity in the house
If you don’t have a lot of equity built up in your home, a personal loan can be a way to fund a small to medium-sized home improvement project, such as a home improvement. B. upgrading your kitchen appliances or replacing an outdated HVAC system.
Your credit rating is excellent
Your credit and financial history plays a big role in whether a personal loan is right for your next project. The higher your credit score, the lower your personal loan interest rate, when all other factors are equal. There is also an increased emphasis on your income and debt to income ratio – your total debt compared to your income – in order to qualify.
“A personal loan is a bit tricky for a bank. There are secured and unsecured personal loans that you can secure with collateral like your car, but that’s not as stable as your home, “says Reed.
Before you apply, get your credit report online and check your credit history with your credit card issuer to see where you end up on the spectrum (both are free and only take a few minutes). If your credit score is in the mid-to-low 600 range or below, it may be worth looking into other financing options or saving enough to pay for the renovation upfront.
“Good credit becomes more important with a personal loan,” says Reed. “If you have poor credit, wait until your credit is in a better position as you will get lower rates and more options.”
When you are sure about your credit score, start collecting documents to show your income and debt-to-income ratio. the lender wants a rate below 43%, says Reed. If your overall financial situation is healthy, the more likely you will be approved for the amount you wish to borrow.
You are ready to trade less fees for a higher interest rate
A home improvement personal loan usually comes with fewer fees than a home equity loan or HELOC.
For example, there are no application fees, evaluation fees, annual fees, points, or title search and title insurance fees, as is usually the case with home equity loans and HELOCs. When comparing the price of a home loan and a personal loan, it is important to consider these additional fees.
The disadvantage of a personal loan is that you will likely have to pay a higher interest rate. Your interest rate and how much money the lender will give you will depend on your creditworthiness, income, and debt-to-income ratio.
You agree to lose tax breaks
If you are using a home equity loan, HELOC, or cash out refinance for home improvements, you can usually deduct the interest on the loan from your taxes. That’s because you are using the funds to buy, build, or significantly improve your home and because it is a secured loan.
If you are using an unsecured personal loan to finance your home renovation, you may not be able to deduct the interest you paid. Be sure to speak to an auditor or tax advisor to get more clarity about your specific situation.
Alternatives to home improvement personal loans
Using home equity is a popular way to fund a home renovation project, more than taking out a home improvement loan. Here are a few options to consider.
Home Equity Line (HELOC)
A HELOC works like a secured credit card with a revolving credit line. You can withdraw up to 85% of the value of your home and withdraw cash as you need it. You can even borrow more when you clear your balance, but you’ll need to put your home on as collateral.
It can be a flexible and inexpensive way to fund an ongoing home improvement project. However, because HELOCs have adjustable interest rates that could rise in the future, Moralez says you should only go this route if you can pay off the debt quickly.
A home equity loan is sometimes called a second mortgage. As with a personal loan, the borrowed money is paid out in advance and paid back over time in fixed monthly installments. With this type of loan, your home serves as collateral.
A cash out refinance resets the clock on your mortgage and works differently than a home equity loan or HELOC.
With this type of refinancing, you’d take out a mortgage for more than you owe on your home and use the difference to finance your home improvement project. This is only an option if you have enough equity in your home.
You have a brand new mortgage and interest rate so you will have to pay the closing costs on the new mortgage. (These costs can be built into the loan so you don’t have to come up with the money upfront.)
But it’s a great option right now while interest rates are extremely low, says Reed. And that makes cash-out refinancing particularly attractive.