How do home improvement loans work?
Senior Content Writer
Quick Insights
- A home improvement loan refers to a form of financing that homeowners may use to pay for renovations, repairs or upgrades.
- Eligibility, borrowing limits and interest rates depend on factors like your credit history, income and existing debt. For secured loan options, your available home equity may also be a factor.
- Additional options to finance home improvements include personal loans, credit cards or secured financial products that require an asset as collateral.
Home improvement loans may help you pay for various projects, from replacing a roof and remodeling a kitchen to making energy-efficient upgrades. Home renovations and repairs can be costly, whether you have to pay upfront or complete projects over a longer period. That’s where a home improvement loan may come in. Let’s review how home improvement loans work, then compare several ways to fund your home project or repair.
Chase does not offer personal loans.
What is a home improvement loan?
“Home improvement loan” is a broad term, not a single financial product, used to describe how you might borrow money to fix or upgrade a home: room remodels, repairs, HVAC replacements, flooring, painting, landscaping or even adding a new room.
The term may describe several financing options, secured and unsecured, including personal loans, HELOCs, home equity loans, or cash-out refinances. Secured financing uses an asset as backing (often the home as collateral), while unsecured financing does not. Approval for either type is based on the borrower’s credit and financial situation. Meanwhile, secured financing—particularly for home equity products—also looks at the property value and mortgage payment history.
How do home improvement loans work?
There are distinct types of home improvement financing. While all the options may serve the same broad purpose of funding your home project, the differences matter when it comes to cost, risk and how you access the money.
Key distinction:
- Loan: A lump sum, often repaid with fixed payments over a set time. You might choose this when your home improvement costs are clear.
- Line of credit: A flexible source of money you borrow over one period and, after that, repay over another. You might choose this when you want flexibility for your project to unfold.
After you apply, the lender usually reviews several factors: credit history, income, assets, liabilities, debt-to-income ratio (DTI). Your home equity may be evaluated, as well. Regardless of the product, you may be able to borrow and repay money for eligible renovation or repair expenses. If approved, you agree to the terms of repayment, often including applicable interest and fees.
Types of home improvement loans
There are distinct types of home improvement financing beyond just loans and lines of credit. Each has its own structure, requirements, benefits and trade-offs. While the options may all serve the same broad purpose of funding your home improvement, knowing the differences can help you choose the right option for you.
1. Personal loan
A personal loan can be used to cover almost any type of expense (although some lenders might limit the ways a borrower may use it). Such flexibility is one benefit of personal loans, alongside a wide range of options to choose from and a relatively quick time to secure a loan.
While other loan types may require a form of collateral, personal loans typically don’t come with that requirement. However, this factor makes it riskier for the lenders, so a personal loan could possibly lead to higher interest rates in comparison to other home improvement loan types.
Chase does not offer personal loans.
2. Home equity loan
A home equity loan is another way homeowners may be able to finance renovations or repairs. This is where a borrower receives money in one sum and repays that amount, plus interest and applicable fees. Repayment is usually at a fixed interest rate for an established period, which can help you plan financially.
A home equity loan uses the house as collateral, which has pros and cons. On the one hand, the amount you’re able to borrow is based on your current equity. On the other hand, foreclosure becomes a risk when borrowers are not able to repay the loan.
3. Home equity line of credit (HELOC)
A home equity line of credit (HELOC) is a revolving line of credit secured by your home. Instead of receiving the full amount as a lump sum, you receive an approved credit limit. You can borrow against it during a designated draw period, which may be several years. Interest is generally charged only on the amount borrowed, and many HELOCs have variable interest rates.
Once the draw period ends, you enter the repayment period and typically can’t borrow anymore. Your payments may increase because you’ll begin repaying the outstanding principal and interest. As with a home equity loan, your home serves as collateral, so failing to repay a HELOC as agreed could put your property at risk.
Availability varies by lender and state. For example, Chase does not offer its HELOC product in Texas.
4. Cash-out refinance
A cash-out refinance replaces your existing mortgage with a new, larger mortgage. The difference between the new loan amount and the amount needed to pay off your current mortgage is provided to you in cash. This can typically be used as you see fit, including home improvements or other expenses.
Example:
- Existing mortgage balance: $220,000
- New mortgage: $280,000
- Cash to you: About $280,000 − $220,000 = $60,000 before closing costs and fees
The new mortgage pays off the existing $220,000 balance, and the remaining funds may be used for home improvements or other expenses. A cash-out refinance may change your interest rate, monthly payment and repayment period. Depending on your home value, cash-out refinancing may reduce your home equity.
5. FHA 203(k) loans
Unlike financing that generally depends on existing home equity, an FHA 203(k) loan may allow eligible homebuyers or homeowners to finance the purchase or refinancing of a qualifying property together with eligible repairs or improvements. An FHA 203(k) loan is a government-insured mortgage that may allow eligible borrowers to finance the purchase or refinancing of a home and its rehabilitation through one loan. A portion of the loan pays for the home purchase or existing mortgage. Meanwhile, money designated for eligible renovations is generally placed in an escrow account and released as the work is completed.
Program requirements, eligible improvements and renovation procedures vary. Chase does not offer FHA 203(k) loans.
Factors to consider before taking out a home improvement loan
Different home improvement loans may be more suitable than others, depending on your project or situation. Here are some factors to remember when choosing.
- Eligibility: Requirements vary by lender and financing type but may include minimum credit standards, verifiable income and a certain DTI. For financing secured by your home, the mortgage lender may also review your available equity and property value.
- Project size and cost: Estimate the full cost of labor, materials, permits and potential unexpected expenses. A smaller project may make one financing option more practical than it would be for a major renovation.
- Available home equity: Home equity may affect whether you qualify for financing that’s backed by your home (HELOC, home equity loan or cash-out refinance). Your equity can also determine how much the lender lets you borrow.
- Time considerations: Application, home appraisal and funding timelines vary by financing type and lender. If it’s an emergency repair, you may want to ask when money would be available as you compare options and lenders.
Pros and cons of home improvement loans
Home improvement financing may provide access to funds for repairs or renovations, but the costs and risks depend on the option selected.
Advantages of home improvement loans
- Multiple financing options are available for different project sizes, timelines and borrowing needs.
- Financing may allow homeowners to complete necessary repairs without paying the entire cost upfront.
- Secured and unsecured options may be available, depending on the borrower’s qualifications.
- Certain products may provide either a lump sum or ongoing access to funds as the project progresses.
Disadvantages of home improvement loans
- Interest and fees increase the total cost of the renovation.
- Secured financing reduces available home equity and puts the property at risk if the debt isn’t repaid.
- Variable interest rates may cause monthly payments to change.
- Some options may include closing costs, appraisal requirements or restrictions on how the money is used.
In summary
Home improvement financing may help cover eligible repairs, renovations or upgrades, but the costs, terms and permitted uses depend on the option you use. As you compare, the project’s size and timeline are important to consider as the financing terms: interest rate, fees, repayment period, amount/borrowing limit, funding timeline and whether collateral is required.
Whether you’re making necessary repairs or upgrading for comfort and value, financing can let you fund important work without using your savings exclusively.
FAQs about home improvement loans
1. Are home improvement loans tax deductible?
The deductibility of interest depends on the financing type and the customer’s tax circumstances. For certain loans secured by a qualified home, interest may be deductible when the proceeds are used to buy, build or substantially improve the home securing the loan, subject to applicable IRS requirements and limits. Consult a qualified tax professional about your situation.
2. What credit score do you need for a home improvement loan?
Minimum credit requirements vary by lender and product. Stronger credit may improve eligibility and pricing. Lenders don’t just look at your credit score. They tend to consider your income, debt-to-income ratio, employment history and mortgage payment history, among other factors. For financing secured by your home, the lender may evaluate your available home equity, as well.
3. Can you use a home improvement loan for anything?
Not necessarily. Permitted uses depend on the financing type and lender. Money may be available for various projects on your property: kitchen or bathroom remodeling, roof repairs, energy-efficient upgrades, home additions, etc. However, some lenders may restrict how the money is used or require documentation, such as project estimates, contracts or receipts.
