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Reader-friendly guide to home improvement loans
What is a home improvement loan? Any loan used to improve or make repairs to your residence, regardless of the loan type.
These can include a new kitchen, replacing roof, building an addition, upgrading your furnace or water heater, new windows or general property improvements. Improvements to the property outside the home itself, like landscaping or swimming pools in many cases can also be considered home improvements.
Home improvements will generally enhance the value of the property so that it increases the expected sales price, but that is not a requirement.
Types of home improvement loans
There are several different financing options available for home improvement loans.
- Home equity loans/lines of credit
- Primary mortgage loans
- Cash-out refinance
- Government-backed loans
- Reverse mortgages
- Unsecured loans (Personal loans, credit cards)
- Contractor financing
The type of home improvement loan you choose will depend on a number of factors, including your personal finances, how much you need to borrow, how much home equity you have, your credit scores, whether you're improving a home you plan to buy or the one you already own, etc.
Before considering loans for home improvements, you should have a detailed plan for the work you intend to carry out. This plan you should include exactly what you plan to do, the materials you will need, the estimated cost of the improvements, the contractors and subcontractors to be involved and often, the estimated value the improvements will add to your home.
While this last item is not always required, in some cases you will need to present it to your lender as part of your loan application. It's also a good thing to know when deciding whether the cost of a project is justified – many home improvement projects add only negligible value to the property, compared to their cost. It's therefore a good idea to get estimates from a contractor or real estate professional; you may also need to obtain a professional appraisal in some cases.
You can apply for a home improvement loan at any lender; you don't have to use the one who currently holds your mortgage.
Questions to ask yourself
Before seeking a loan for home improvement, here are some of the main questions you should be able to answer.
- What will your monthly payments be for the loan?
- What are the tax implications? Will your property taxes rise?
- How much will the improvements increase the value of your home?
- Will the project cost significantly more than the increase in property value?
- Will there be any ongoing costs associated with the project? (such as maintaining a swimming pool)
- How will the project affect your ability to eventually sell the home?
Home improvement loan options
As noted above, you have a number of different options when it comes to home improvement loans. The one you choose will depend on what you can qualify for and gives you the best deal under your specific circumstances.
Home equity loans
The most common type of home improvement loan is a home equity loan. This can either be a standard home equity loan or home equity line of credit (HELOC). Because they're secured by the equity in your home, they can offer low interest rates and the interest you pay is usually tax-deductible.
Home equity loans are a type of second mortgage; that is, they're a home loan that's subordinate to the primary mortgage used to purchase the property. They're called secondary because in the event of a foreclosure, they don't get paid until the primary mortgage is completely paid off.
Home equity loans and HELOCs typically have few limits on how you can use them, so you don't need to submit detailed plans on the improvements you want to make to qualify for the loan.
A standard home equity loan provides you a single sum of cash to spend as you wish and is typically a fixed-rate loan repaid over 10-20 years. They're a good choice for short-term projects where you're going to pay for the whole thing all at once.
A HELOC sets you up with a line of credit, similar to a credit card, which you can draw against as you wish. They're good for situations where you need to borrow varying sums over time, such as an extended home improvement project or if you plan to do several projects over the coming years. These are adjustable-rate loans while you're borrowing money, but usually can be changed to a fixed-rate when it comes time to pay them back.
In some cases, you're looking to both buy a home and borrow money to make repairs or improvements to it at the same time. This option allows you to do both with a single loan, rolling the cost of the improvements into your primary mortgage, the one used to buy the property.
Both the FHA 203(k) loan and the Fannie Mae HomeStyle Rennovation Mortgage allow you to purchase a home and borrow additional funds for improvements with a single loan. Each allows you to borrow more than the actual price of the home in order to cover the cost of repairs or upgrades.
In both cases, the maximum you can borrow is tied to the expected value of the home after improvements, though the way that is calculated differs between the two loans.
The Fannie Mae HomeStyle loan often has lower costs for borrowers with good credit, has higher loan limits in many areas and is more flexible in terms of the improvements that can be funded with it and can be used for investment properties.
The FHA 203(k) is easier to obtain for borrowers with lower credit scores, allows you to borrow more in relation to the home's anticipated value after improvements and offers a simplified option that requires less paperwork on smaller projects.
This offers you another way to borrow against your equity to get a loan for home improvement. But instead of taking out a loan based on part of your home's value, you're refinancing the entire mortgage and taking out some money as part of the process.
Let's say your home is worth $250,000 and you owe $100,000 on your mortgage. You could do a cash-out refinance that would give you $50,000 for renovations and leave you with a new mortgage with a balance of $150,000.
A cash-out refinance is a good option if you can reduce your mortgage rate in the process. However, the closing costs associated with refinancing the entire mortgage will be higher than on a home equity loan or line of credit.
A cash-out refinance can also be a good choice if you need to borrow a large sum of money. You can get a lower fixed rate than on a standard home equity loan and avoid the uncertainty that comes with the adjustable rates on HELOCs. You can also take longer to repay the loan with a cash-out refinance, up to 30 years.
Government home improvement loans
Owners of a single-family home can borrow up to $25,000 with a Title 1 home improvement loan for modest repairs or improvements that enhance the livability of the residence. In many cases, the work can be done on a do-it-yourself basis.
A Title 1 home improvement loan is like a home equity loan, except that you don't necessarily need to have home equity to qualify. The loan is secured by your property, but is based on the enhanced value of your home after improvements, much like an FHA 203(k) loan.
These are fixed-rate loans that can be repaid over a period of up to 20 years, with no penalty for early repayment.
Title 1 loans cannot be used to finance luxury improvements such as a hot tub or outdoor fireplace, but can be used for such things as new appliances, energy-efficiency improvements, general repairs or disability access such as a wheelchair ramp or lowered kitchen cabinets.
A Title 1 is one of the better options available for a mobile home improvement loan. You can borrow up to $25,090 for improvements to a mobile home permanently established on a privately owned lot; that is, one that qualifies as real estate. Title 1 allows unsecured home improvement loans are available in amounts of $7,500 or less, which can be used for manufactured homes on leased lots.
Owners of a multi-unit dwelling can borrow up to $60,000 toward improvements, or a maximum of $12,000 per unit.
Title 1 loans are backed by the FHA/HUD, and are available through FHA-approved lenders.
Other government home improvement loans would include the FHA 203(k), listed above in the primary mortgage section, and FHA reverse mortgages, described below.
A reverse mortgage can be used as a home improvement loan for seniors. These are a special type of home equity loan for borrowers age 62 and above.
They work much like other home equity loans, except that you don't have to repay them as long as you live in the home. Instead, the loan and interest are repaid when you eventually vacate the property. This is usually done with the proceeds from selling the home.
Reverse mortgages can be a good choice for older borrowers on a fixed income, as you don't have to make monthly payments. However, their overall costs are higher than on other types of home equity loans.
Most reverse mortgages are backed by the FHA, where they are called Home Equity Conversion Mortgages (HECMs). You would obtain these through an FHA-approved lender. Other lenders may offer non-FHA reverse mortgages with more flexible terms.
You can generally use the funds from a reverse mortgage for any purpose you want. However, some types are designed to be used specifically as home improvement loans or for another dedicated purpose. These "single-purpose" reverse mortgages are usually offered through a state or local government agency or nonprofit organization, and are targeted at homeowners with low to moderate incomes. They are not available in all areas.
Unsecured home improvement loans
A final option would be an unsecured loan, such as a personal loan obtained from a bank or other lender, or using a credit card, either by obtaining a cash advance or charging materials directly to it and doing the work yourself.
An unsecured home improvement loan typically charges considerably higher interest rates than on a secured loan, unless you can take advantage of a temporary no-interest or low-interest period on a credit card cash advance. On the other hand, there are certain advantages as well.
An unsecured loan does not require that you have any home equity, so it's an option for borrowers who are lacking in that regard. For borrowers whose homes are on leased land and which are not considered real estate, it may be one of the only options.
You're also not putting your property at risk with an unsecured home improvement loan, since you're not using it as collateral. If you fail to repay the loan, the lender cannot foreclose on you. In the case of a credit card/cash advance, there's also the convenience of not having to go through a new loan application process and having the funds almost immediately.
As noted above in the government home improvement loans section, the Title 1 program also allows unsecured loans of $7,500 or less.
Many contractors who do home improvement projects offer their own financing, particular those that specialize in specific types of work such as windows, roofing, driveways, heating and cooling systems and the like.
These offer the convenience of dealing with a single entity for both your financing and your home improvement project. On the other hand, the interest rates charged tend to be significantly higher than if you'd obtained your own home improvement loan separately.
In addition, financing through the contractor means you don't have much leverage in case the work is not done to your satisfaction. You're already committed to a payment schedule, so it can be difficult to refuse to pay until they make things right.
There are many different types of home improvement loans available to meet the needs of homeowners. Some will be a better choice than others, depending on your home improvement goals and personal circumstances.