Couple with paint and ladder

Home Improvement Loans: What They Are, How They Work, And How To Get One

Carey Chesney6-Minute Read
January 18, 2022

Thinking about home improvements? Were you looking for your dream home and settled for that “OK for now” house? Or maybe your home has worked great for your family, but that family is expanding? Or perhaps you’ve always had renovation plans in your mind but just don't have enough money saved up to make them a reality.

Well, home improvement loans are here to save the day. Your dreams of tweaking your abode so it fits you and your family a little bit better can come to life even if you don’t have the cash on hand to pay for it.

What Is A Home Improvement Loan?

A home improvement loan, or home renovation loan, is money you borrow from a financial institution in order to finance upgrades and costly repairs to your home. These projects may enhance the livability and usability of the house, remove health and safety hazards, improve aesthetics of the home or save energy.

A home improvement loan is often used for more extensive and expensive home improvements, such as a full room remodel, creating an addition, fully updating and remodeling an older home, or replacing several outdated home systems (like older plumbing and electrical or a roof) all at one time. The beauty of a home improvement loan is that homeowners can borrow what they need to make the repairs immediately and pay back the amount over time at much lower interest rates than what credit cards provide.

How Do Home Improvement Loans Work? 

Much like a traditional mortgage loan, a home improvement loan involves borrowing a set sum of money and paying it back to the lender in monthly installments. The difference between different types of home improvement loans is in the amount borrowed, and how you use the loan. If you have both a mortgage and a home improvement loan, you’ll make two monthly loan payments each month.

Start Your Next Home Project Today.

Discover your personal loan options with just a few clicks.

How To Get A Home Improvement Loan

With decent credit and a solid repayment history, obtaining a home improvement loan for your property is a direct and transparent process, not unlike taking out a mortgage loan or applying for a credit card. When shopping for any financial product, it’s best to begin by looking into multiple lenders and loan products in order to determine the best term and home improvement loan for your needs.

1. Compare Home Improvement Loan Rates And Terms

A quick online search for home improvement loans will provide you with a ton of options – almost too many. To evaluate which home improvement loan is the best for your financial situation, it’s standard practice to consider the following factors before applying:

  • Annual percentage rates: This refers to the annual cost of the loan to the borrower. This includes interest, mortgage insurance, closing costs, loan origination fees and discount points. (And yes, depending on the type of loan you apply for, there may be a new set of closing costs!)
  • Loan amount: This is the amount of money being borrowed. In order to ensure you’re not borrowing too much or too little, it is best to have contractors come bid the home improvement projects you want completed, so you have a very specific idea of how much money you’ll need to borrow in order to get your project done.
  • Loan term: This refers to the length of time a borrower has to repay the loan. Loan terms and repayments vary by type of home improvement loan and lender.
  • Credit requirements: A borrower’s credit score can affect their interest rate for the loan. The better your score, the better interest rate you will get. Typically, a minimum credit score of 620 is required to qualify for most home improvement loans, but there are always exceptions, so ask your lender what credit score you’ll need. If your credit score could use a refresh, try working to improve your score before you apply.

2. Apply For A Home Improvement Loan

Once you have compared the various loans and are ready to apply for the one of your choice, expect to include the following pieces of information during application:

  • Credit history and score requirements
  • Proof of income
  • Debt-to-income ratio
  • Property type
  • Type of renovations
  • Amount of money you wish to borrow

Keep in mind also that depending on the type of loan you get, you may be required to supply additional documentation. When utilizing an FHA 203k loan product, for example, this type of loan will require applicants to use an approved contractor, have a renovation budget and have a specific timeline of when the improvements are expected to be complete.

3. Receive Your Money And Start The Repayment Process

Once your loan application is accepted and you close on the loan, your money for home improvements becomes available. Depending on the type of loan, the lender may wire money into the bank account of your choice, or if it is a HELOC, you will have a line of credit to draw down from.

Again, how the money comes to you will vary by the type of home improvement loan you applied for, but the most important thing to remember is to set up repayment options in order to pay on time and keep your credit healthy.

Fund your renovations with a cash-out refinance.

Get approved online now!

NMLS #3030

Best Loan Types For Home Improvement

Home improvement loans come in many shapes and sizes: home equity loans, home equity lines of credit (HELOCs), and cash-out refinances (cash-out refis) are all typical home improvement financing options, and may in fact result in more tax breaks, lower payments, and a greater return on investment for home repairs.

It’s important to note that some home improvement loans are secured and others are unsecured. With a secured loan, like a HELOC or cash-out refi, the borrower’s home may be used as collateral. This means if you don’t make your payments on the loan, the lender can take your house. With an unsecured loan, like a standard home improvement loan or personal loan, you aren’t offering your home up at collateral.

Cash-Out Refinance

With a cash-out refinance, homeowners are able to convert existing home equity into cash. A cash-out refinance isn’t a second loan (like a home equity loan or HELOC) – the refinance replaces your original mortgage and becomes your new loan. For example, if you have a $200,000 mortgage on a home valued at $400,000, you could borrow on your $200,000 in equity. If you wanted to do a whole home remodel at a cost of $60,000, your new cash-out refinance mortgage amount would be $360,000. Your old mortgage loan would be replaced with this new mortgage, and you’d be given a check for $160,000.

While this option has the lowest interest rate of your home improvement loan options, it also has some drawbacks. You’ll need to pay closing costs and go through the full mortgage process to get the loan, so make sure that the amount of costs doesn’t outweigh the savings of the low rates you’ll enjoy with a cash-out refinance. 

Personal Loan

A personal loan is one of the only alternatives on our list that doesn’t require you to use the equity in your home or your home itself as collateral. When it comes to how much you can borrow with a personal loan, a lender will decide that based on several factors, including your income and credit history. When you take out a personal loan, you’ll have a specific amount of time to pay it back, and once you pay it back in full, your account will be closed. Just like any other loan, you will pay interest on the money you borrow.

That interest rate will be determined, in part, by your credit score. Since credit plays a major role in these types of loans, be sure you know what yours is and make sure it’s good. If you plan on using a personal loan to make renovations to your home, Rocket Loans offers a Home Improvement Personal Loan for doing just that. 

Home Equity Loan

A home equity loan is similar to a personal loan, except it allows you to borrow up to the amount of equity in your home (the amount you are allowed to borrow varies by lender and mortgage type, but most allow up to 80% of your total equity in the home). The main exception to this is the VA loan, which allows 100% cash-out. While a HELOC is a line of credit a homeowner can draw against with a variable interest rate, a home equity loan is a lump sum, dispersed at one time, with a fixed interest rate. A home equity loan is a type of secured debt, meaning your property itself is the collateral. The biggest drawback to this type of loan is that if you default on the home improvement loan, the bank can take your house.

The biggest advantage to home equity loans, however, is that you can borrow equity you’ve built in your home, the funds are dispersed at once and these loans are often offered at a relatively low fixed interest rate.

Home Equity Line Of Credit (HELOC) 

A home equity line of credit (HELOC) is a unique financial product with several key differentiators from its cousin, the standard home equity loan. Similar to a home equity loan, a HELOC enables a homeowner to borrow from equity they’ve built. The difference is that instead of borrowing a lump sum amount – a HELOC acts more like a credit card, with a line of credit established for you to borrow from when you need the cash.

Usually, HELOCs come with variable interest rates, so there isn’t a set monthly payment. This option can be attractive to homeowners who don’t know which repairs are needed yet, and don’t want to borrow more than they need.

Much like a credit card, you can borrow up to a certain amount of money and any balance carries over month to month. Unlike when you refinance for home improvements, you’ll only be charged interest on money you use. 

FHA 203(k) Mortgage Program Loan

One of the Federal Housing Administration’s top home improvement loan programs is the Federal Housing Administration (FHA) 203(k) loan, which allows homeowners to finance home improvements and repairs by lumping them in with their mortgage loan amount and payment. Lenders do this by allowing borrowers to simply add the loan to their mortgage through a refinance or new home purchase.

Once you use the loan to purchase a home or pay off an existing mortgage, the remaining funds are used to pay for the home improvement as work is completed. Since the loan is insured by the government, there are a few restrictions you must adhere to. For example, you cannot do the work yourself, nor can you use your proceeds to fund any “luxuries,” like a swimming pool or tennis court. FHA 203k loan availability also varies by county and property. The Department of Veterans Affairs offers a similar option called a VA renovation loan. With this program, all repairs need to be improvements in livability, accessibility or safety.

You’re also under a tight deadline of 6 months to get the project done, and you must borrow at least $5,000. A letter certifying the work was finished is also required at the end of the project.  With the standard FHA loan down payment amount of 3.5%, however, the 203k loan product can be a fantastic option for homeowners who want to buy a home and borrow to renovate with little cash down.

The Bottom Line: Get A Home Improvement Loan That Best Fits Your Needs

If your home is in need of repair but you don’t have the funds to finance it, don’t panic. Home improvement loans can be a fantastic financing option, especially if repairs are needed immediately and there isn’t time to diligently and consistently save on a monthly basis, and in certain instances the interest can be tax deductible.

The most important things to know about how to get a home improvement loan are:

  • Evaluate the myriad home improvement financing options and select the best one for you. Cash-out refinance, home equity loan, HELOC or a government-backed renovation loan are the most popular and widely available options for homeowners.
  • Compare lenders by evaluating interest rates, loan terms and repayment options.
  • Apply for your loan and complete underwriting and closing.
  • After funds are dispersed, schedule your repayment so that you don’t forget to pay off the home improvement loan monthly.

For those ready to explore home improvement loan options, click here to get approved for a cash-out refinance.

Need extra cash for home improvement?

Use your home equity for a cash-out refinance.

NMLS #3030

Carey Chesney

Carey Chesney brings a wealth of residential and commercial real estate experience to readers as a Realtor® and as a former Marketing Executive in the fields of Health Care, Finance and Wellness. Carey is based in Ann Arbor and attended the University of Wisconsin-Madison, where he majored in English, and Eastern Michigan University, where he recieved his Masters in Integrated Marketing & Communications.