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What Is a Home Improvement Loan & When Should You Use One?

Is your downtown bungalow stuck in the 1980s? If so, it might be time for a full home remodel. But what if you don’t have the cash to hire a professional to swap out the shag carpet and wood paneling of yesteryear? That’s where a home improvement loan comes in.

A home improvement loan is a financing tool that allows homeowners to borrow money for necessary repairs. These loans come in different shapes and sizes, each designed with a different borrower in mind. The right lending option for you depends on factors like:

  • How much money you need
  • The value of your home
  • Your debt-to-income ratio
  • Your credit score 

Keep reading for more information on how a home improvement loan can bring new life to your home.

WHAT IS A HOME IMPROVEMENT LOAN?

A home improvement loan is any type of financing used to fund home repairs. You might be borrowing money from a bank or charging expenses to a credit card. Regardless of the lender, most home improvement loans are repaid over the course of several years.

What’s the catch? Like any other lending option, home improvement loans charge interest. Depending on the type of loan you choose, this interest rate may be very low (0-4%) or very high (>25%).

SECURED VS. UNSECURED HOME IMPROVEMENT LOANS

Do you want to remodel your kitchen? Or maybe renovate a bathroom? If so, you’re in luck. There are many different lending options for homeowners hoping to finance a remodel.

Generally, these loans fall into one of two categories:

  • Secured: A secured loan requires collateral (an asset that a lender accepts as a security). Typically, your house acts as collateral for a home improvement loan. That means if you don’t pay back the money you borrow, the lender can foreclose on your home.
  • Unsecured: No collateral is needed for an unsecured loan. However, these loans are often more difficult to qualify for and may have less favorable terms (think: high interest rate). Plus, defaulting on unsecured debt could lead to bankruptcy.

TYPES OF SECURED HOME IMPROVEMENT LOANS

Borrowers generally prefer secured home improvement loans because they offer lower interest rates and more flexible loan terms. However, since these financing tools require some form of collateral (typically your home), they can be risky.

HOME EQUITY LOAN

A home equity loan, also called a second mortgage, allows you to borrow against the equity in your home.

Equity is the difference between your current mortgage balance and your home’s value. So, if you owe $350,000 but your home is worth $400,000, you have $50,000 of equity. Lenders generally allow homeowners to borrow around 80-85% of their home’s equity (about $40,000 in this example).

This financing option offers competitively low interest rates and flexible loan terms. However, if you default, the lender can foreclose on your home.

PROS

  • Fixed monthly payments
  • Lower interest rates 
  • Longer repayment term

CONS

  • Requires equity in the home
  • Home is collateral
  • Borrowing limits

HOME EQUITY LINE OF CREDIT (HELOC)

Like a home equity loan, a home equity line of credit (HELOC for short) allows a homeowner to borrow against their home’s equity. However, instead of receiving a lump sum, you’re granted a revolving line of credit.

A HELOC is more attractive to homeowners who aren’t sure how much their remodel will cost. Rather than pay interest on a huge amount, you can withdraw money on an as-needed basis. 

The downside? HELOCs are typically repaid at a variable interest rate. That means your APR will ebb and flow based on market conditions.

PROS

  • No closing costs
  • Flexible borrowing
  • Longer repayment term than credit cards

CONS

  • Requires equity in the home
  • Home is collateral
  • Variable interest rate

CASH-OUT REFINANCE

Homeowners may also consider a cash-out refinance. With a cash-out refinance, you replace your existing mortgage with a new, larger loan. This loan pays off your original mortgage. Then, you can use the remaining cash for home repairs (or anything you’d like).

For example, let’s say that you owe $150,000 on your current mortgage and your lender qualifies you for a $200,000 cash-out refinance. At closing, you would receive a check for the difference ($50,000).

Since you receive a large lump sum, cash-out refinances are great for intensive home repairs like a kitchen remodel. However, this is only a solid financing option if you plan on staying in your home for several years. If you plan to move soon, a cash-out refinance isn’t for you.

PROS

  • Lump sum at closing
  • Longer loan term (15 to 30 years)

CONS

  • Closing costs
  • Foreclosure risk
  • Higher mortgage payments

TYPES OF UNSECURED HOME IMPROVEMENT LOANS

With an unsecured loan, there’s no risk to personal property. That means you don’t have to worry about losing your home or other assets if you default. However, you can expect higher interest rates and a shorter repayment term.

PERSONAL LOAN

A personal loan is the most common type of unsecured home improvement loan, and with good reason. Homeowners can qualify for a personal loan within minutes, especially if they apply with their current bank or credit union.

Since no collateral is needed, the approval process is fairly straightforward. Your lender will likely assess your creditworthiness and evaluate your debt-to-income ratio. Once approved, the funds will be transferred to your bank account within a few days.

A personal loan is a great option for homeowners who don’t have enough equity in their homes to qualify for a secured lending option. The downside? You might get stuck with a high interest rate, especially if you have less-than-perfect credit.

PROS

  • Quick and easy approval process
  • No collateral
  • No early repayment fee, depending on the lender

CONS

  • High interest rate
  • Shorter repayment period
  • Smaller loan amount

CREDIT CARDS

Have you considered tapping a credit card to fund your home improvement project? If not, give it some thought. Many credit cards offer “teaser” rates that are well below the market average. Some even offer zero-interest periods for one to two years.

However, you should only use a credit card if you know you’ll be able to pay it off before the promotional period ends. If you don’t pay back your debts, you could face astronomically high interest rates.

That being said, credit cards work best for smaller home improvement projects like new cabinet hardware or an upgraded vanity.

PROS

  • Convenient 
  • No collateral 
  • Low-interest or zero-interest periods

CONS

  • High interest rate
  • Limited borrowing power
  • High monthly payments

WHICH HOME IMPROVEMENT LOAN IS RIGHT FOR ME?

Before you rack up credit card debt or refinance your mortgage, you need to select a home improvement lending option that suits your needs.

Start by asking yourself these questions:

HOW MUCH MONEY DO I NEED?

If it’s less than $20,000, there’s no need to pay the closing costs associated with a secured financing option. Instead, opt for an unsecured personal loan with a low interest rate or a credit card with a zero-interest period.

DO I HAVE ENOUGH HOME EQUITY?

If you hope to borrow a large sum, a secured home improvement loan is best. However, to qualify for this lending option, you must have equity in your home.

Connect with your mortgage lender to determine your current balance. Then, use real estate websites like Zillow and Redfin to compare your house to other properties in the area. This can help you estimate your equity.

CAN I AFFORD A HIGHER MORTGAGE PAYMENT?

With a cash-out refinance, you’ll walk away with enough money to upgrade your shag carpet. However, you’ll also walk away with a higher mortgage payment. Do you have enough wiggle room in your monthly budget to afford this?

Comparatively, if you move forward with a home equity loan, you’ll have not one mortgage but two. Can you juggle two payments each month?

CONNECT WITH A RELIABLE CHARLOTTE LENDER

Once you have a better idea of how you’d like to fund your home remodel project, reach out to a local lender like Dash Home Loans. As a trusted partner of Team Portico, Dash Home Loans offers dozens of financing options at great rates.

What’s even better? Dash has reimagined the lending process, making it easier and speedier than ever. That means you’ll receive the money needed for your bedroom overhaul faster than you can say “home sweet home.”

Interested in learning more? Call 704-912-0020 to connect with a Mortgage Coach at Dash’s Charlotte office.

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