If you’re a “glass half-full” person, a home improvement project is an exciting opportunity to improve your quality of life, increase your home’s value and exercise your creativity.
You’re ready to wage war on a woefully outdated kitchen.
If you’re the “glass half-empty” type, you’re dreading the process, but can no longer put off dealing with the cracked vinyl siding and leaky windows.
Whatever your outlook, home improvements and repairs can get very pricey, very fast. A minor kitchen remodeling costs an average of $20,830, vinyl window replacement is $15,282, and the addition of master bedroom could easily cost a cool quarter-million dollars.
Unless you’ve socked away some “real money,” you’ll need a home improvement loan to finance such projects.
But what type of loan, and lender, is right for you?
The Complete Guide to Home Improvement Loans sorts out the different types of home renovation loans, so you can find one that meets your remodeling needs — and your budget.
Most important, it can help you find loans for which you qualify, even if your credit score is nothing to brag about.
Home Renovation Loan Options
Cash-out Mortgage Refinances
A cash-out mortgage refinance is one of the most common ways to pay for home renovations. With a cash-out refinance, you refinance the existing mortgage for more than the current outstanding balance. You then keep the difference between the new and old loans.
For example, if you owe $200,000 on a home worth twice as much, you can take out a loan for $300,000, replacing the former loan and receiving cash back at closing. The new mortgage might even come with a lower interest rate or smaller monthly payments.
There are two types of cash-out refinances: government-backed and conventional.
Conventional cash-out refinances. If you have a lot of equity in your home, a cash-out refi lets you free up a sizeable sum for expensive renovations. However, if you don’t have enough equity or your credit score is lackluster, you may find it difficult — or impossible — to qualify for a loan in the amount you need.
In general, cash-out refinances are limited to an 80% loan-to-value ratio (LTV) — the amount of the loan vs. the home’s market value. In theory, this finance type is available to people with credit scores as low as 620. In reality, many lenders set their minimums around 640 or even higher.
If you do qualify, despite a mediocre score, you’ll pay more in interest and fees than someone with an impressive credit history. For example, a homeowner with a 680 credit score and LTV of 80% will pay 1.75% of the loan amount more in fees than an applicant with a 740 score and a 60% LTV.
In other words, the better your score, and the more equity in your home, the less you’ll pay in interest.
- Larger loan sizes (in many cases)
- Fixed interest rate. This lets you calculate the total cost of the loan — upfront
- Higher rates than primary mortgages and no-cash-out refinances
- Closing costs can total hundreds or thousands of dollars
- A time- and document-intensive application process (similar to that for a first mortgage)
FHA Cash-out Refinances. Cash-out refinances backed by the Federal Housing Administration (FHA) reduce risk to lenders. That’s why homeowners with lower credit scores and higher debt-to-income ratios are more likely to qualify for the money they want.
In addition, FHA cash-outs have a maximum LTV of 85% instead of the 80% limit on most conventional cash-outs.
In theory, you can qualify with a credit score as low as 580. In reality, most lenders want to see a minimum score between 600 and 660.
- The 85% maximum LTV lets you borrow more money
- Fixed interest rate
- You may be able to lower the rate and change the terms while borrowing extra money — e.g., converting a 30-year fixed to a 15-year fixed
- You will incur an upfront fee of 1.75% of the loan amount, wrapped into the new loan
- Monthly mortgage insurance required of $67 per month per $100,000 borrowed.
VA Cash-out Refinances. Cash-out refinances guaranteed by the Veterans Administration (VA) are similar to those backed by the FHA. The main difference, of course, is that only eligible service persons and veterans may apply. VA cash-outs can be used to refinance previous VA-backed loans and non-VA loans.
The biggest advantage to VA cash-out loans is that you can finance up to 100% of your home’s current value.
So, even if you only have 10-15% equity in your home, it still might make sense to use a VA loan for cash. No other loan program lets you get that high of an LTV with a cash-out loan.
Although VA cash-out refinances have the same loan limits as VA home purchase loans ($484,350 for a one-unit home in most of the U.S.), few borrowers come close to that limit. (In 2016, the average VA refinance loan was just over $250,000.)
- Good tool for quickly raising large amounts of cash
- Fixed interest rate
- Because VA loans do not require mortgage insurance, you can reduce homeownership costs by paying off an FHA loan and canceling your FHA mortgage insurance premiums (MIP). You can also refinance out of a conventional loanthat requires private mortgage insurance (PMI)
- Higher rate than other types of VA-backed mortgage refinances
- A new property appraisal and income verification is required
- You need to establish eligibility based on military service
Home Equity Loans and HELOCs
Home Equity Loans. Basically, a home equity loan is a fixed-rate personal loan that is secured by your house. In most cases, you can borrow up to 80% of your home’s market value minus what you still owe on the mortgage. So if your house is worth $300,000, and you have an outstanding balance of $200,000, you can borrow up to $40,000.
On the plus side, home equity loans tend to be approved faster than cash-out refinances. They also tend to have lower closing costs. On the minus side, you may have to settle for a smaller loan and a higher interest rate.
- Good and fast way to raise a lump sum
- Fixed interest rate
- Loan is fully amortizing. You repay interest and principal from the get-go
- Closing costs are often lower than for cash-out refinances
- Rates are usually higher than for cash-out refinances
- Because loan amounts tend to be smaller, they might not cover the full cost of your home improvement project, especially if you go over-budget
Home Equity Lines of Credit (HELOCs). HELOCs are revolving credit lines that typically come with variable rates. Your monthly payment depends on the current rate and loan balance.
HELOCS are similar to credit cards. You can draw any amount, at any time, up to your limit. You’re allowed to pay it down or off at will.
HELOCs have two phases. During the draw period, you use the line of credit all you want, and your minimum payment may cover just the interest due. But eventually (usually after 10 years), the HELOC draw period ends, and your loan enters the repayment phase. At this point, you can no longer draw funds and the loan becomes fully amortized for its remaining years.
- Borrow as much or as little as you need — when you need it
- Low monthly payments during the draw period
- Low closing costs
- Variable interest rates rise in tandem with the Federal Reserve’s prime rate
- Monthly payments can skyrocket once the repayment phase begins — i.e., once you begin repaying both principle and interest on the loan
Personal Loans and Lines of Credit
There are two basic types of personal loan and line of credit — those secured with collateral, such as your home or an automobile, and those unsecured by assets (in which case, lenders take a much harder look at your credit score, employment history and income).
Only homeowners with little or no equity have a good reason to opt for these loans, so we’ll focus on the unsecured type.
Personal Loans. You don’t put up collateral for an unsecured personal loan, so you don’t risk losing your home or car in the event of default. Otherwise, the chief advantages are the relative speed and simplicity of the application and approval processes compared with mortgage refinances, home equity loans and HELOCs.
On the other hand, the rates for personal loans are significantly higher than for cash-out refinances and home equity loans. And the loan amounts are usually much smaller.
- No home equity required
- No appraisal required (great if your home is in disrepair)
- Application process is faster and simpler than for other renovation financing
- High interest rates
- Loan amounts are (often) much lower
- Those with poor credit histories may not qualify, or will pay double-digit interest rates
- Loans with lower interest rates may come with (hidden) origination and application fees
Personal Lines of Credit. These are revolving lines of credit that allow you to borrow what you need, when you need it, up to the credit limit. Essentially, they function like credit cards, but without the plastic (unless they’re linked to a debit card).
Although they offer more flexibility than personal loans, personal credit lines have the same drawbacks as personal loans — and then some.
Almost all credit lines have variable interest rates, and if the rate is raised, it can be applied to your existing balance — something credit card companies are not allowed to do. So be sure to check the lender’s offer to see how often, and by how much, it can raise your rate. If you’re not careful, a once-affordable loan balance could become hard to repay.
As of October 2017, credit cards have an average APR of 16.7%, with some charging up to 22.99% on purchase balances. Assuming you don’t pay the entire balance within 30 days, credit cards can be one of the costliest home renovation financing methods.
In general, there’s only one credit-card-financing scenario that makes sense, and only for smaller home renovation projects. Get a new card with an introductory zero-percent APR (the intro period is typically 12 months), use the card to pay for the improvements, and repay the entire balance before the interest rate kicks in.
- Near-instant access to cash
- Speedy and simple application process (for a new card)
- Interest-free loan if you find a card with an introductory offer and pay off the balance within a certain timeframe
- High interest rates (especially for cash advances)
- Low minimum monthly payments can encourage overspending
- Loans are typically limited to four-figure sums.
Government-Backed Loan Programs
FHA home improvement loan – the 203k. These loans can be ideal for buyers who’ve found a house with “good bones” and good location, but one that needs major-league TLC.
A 203k loan allows you to borrow money, using only one loan, for both the home purchase (or refinance) and home improvements.
Most homeowners don’t know that the 203k loan can also be used to refinance and raise cash for home improvements.
The new loan amount can be up to 97.75% of the after-improved value of the home.
For instance, your home is worth $200,000 as-is. Improvements will add $30,000 to the value.
Your refinance loan amount is not limited to your current value. Rather, you could get a loan up to $224,825 (97.75% of future value).
Use the difference between your existing balance and new loan amount for home improvements (after you pay for closing costs and certain 203k fees).
Renovation financing: 203k home purchase
If you’re in the market to buy a fixer, a 203k can help you purchase and repair a home with one loan.
Without a 203k, you would have to find a private home purchase and home improvement loan that would look more like a business loan than a mortgage. They come with high interest rates, short repayment terms and a balloon payment.
203k loans, rather, are designed to encourage buyers to rehabilitate deteriorated housing and get it off the market.
Because 203k loans are guaranteed by the FHA, it’s easier to get approved, even with a credit score as low as 580. And the minimum down payment is just 3.5 percent.
But these relaxed financial standards are offset by strict guidelines for the property. The house must be a primary residence and the renovations can’t include anything the FHA defines as a “luxury.” A list of improvements that borrowers may make can be found here.
Fannie Mae offers a similar home purchase and renovation loan — the Fannie Mae HomeStyle® program — with relaxed home improvement guidelines, but stricter down payment and credit score criteria.
Because of the paperwork involved, and the requirement that you use only licensed contractors, these loans aren’t for people who want to beautify a property themselves. They are best for “hardcore” rehabilitation work.
- May be your most affordable option
- No home equity needed
- People with poor credit may still qualify
- Not available to investors (forget about “flipping”)
- A lot of paperwork must be filled out by you and your contractors
- The process is time-consuming
- Aside from your planned improvements, the FHA might require you to perform additional work to meet all building codes, as well as health & safety requirements
FHA Title 1 Loans. These loans are similar to the others backed by the FHA. In this case, the FHA guarantees loans made to existing homeowners who want to make home improvements, repairs or alterations.
With a Title 1 loan, you can borrow up to $25,000 for a single-family home. For multi-family properties, you can receive as much as $12,000 per living unit, for a maximum of five units (or $60,000). Loans above $7,500 must be secured by a mortgage or deed of trust.
- No home equity needed
- People with poor credit may still qualify
- Maximum loan is relatively small
State and Local Loan Programs. In addition to loan programs run by the federal government, there are thousands of programs operated by the 50 states, as well as counties and municipalities. For example, the state of Connecticut currently lists 11 programs that assist homeowners with everything from financing the purchase of a home in need of repair to helping improve the energy efficiency of their houses.
Each municipality offers different programs with different terms. A quick internet search is all it takes to find such a program.
Alternative Lending Options
Contractor Financing. Yes, your home improvement loan could be as close as the guy sitting on the backhoe in your driveway.
According to a 2016 Consumer Reports survey, 42% of general contractors provide financing options to customers. Other contractors may help you secure a loan from a third party by acting as middlemen.
The rates and terms offered by contractors vary widely, so be sure to get all the details. Then compare them with what’s on offer from banks, credit unions and online lenders.
You can also vet your contractor/lender by searching for online reviews posted by the company’s previous borrowers, as well as your state’s consumer affairs office and the Better Business Bureau. Some contractors are better at home renovation than financial services.
Peer-to-Peer Loans. Peer-to-Peer lending anonymously matches borrowers with lenders through online platforms such as LendingClub and Prosper. (The platforms make money by charging origination fees to the borrowers and taking a cut of the repayments made to lenders.)
For home improvement borrowers, peer-to-peer loans are personal loans that typically range from $1,000 to $40,000 and have terms of one to five years.
As for rates, personal loans facilitated by Prosper and Lending Club both start at 5.99%. From there, the sky is (almost) the limit, with Proper’s rates capped at 36% and Lending Club’s at 35.96%. Given these rates, peer-to-peer lending is not a good option for people with bad credit scores.
Assuming you qualify for a reasonable APR, P2P loans have a number of advantages. The application process is simple and lightning fast. The rates are fixed and, believe it or not, competitive with those offered by some credit cards and banks (for personal loans).
Also, because you remain anonymous to the lenders, you’ll never receive phone or email solicitations from them. Finally, there are no penalties for paying off the loans early.
Home Improvement Financing Companies and Rates
A wide array of financial services companies offer home improvement loans in the form of cash-out refinances, home equity loans, HELOCS, personal loans and personal lines of credit, including national and regional banks, online lenders and credit unions.
Below is a small sampling of lenders that offer personal loans and HELOCs. All rates and terms were as of the time of this writing, and may change at any time.
Current Rates: 9.95% — 35.99%
Fees: 1.50% — 4.75%
Current Rates: 2.29% — 17.49% (with autopay)
Bank of America. One of the largest companies in the world, Bank of America has operations in all 50 states, the District of Columbia and 40 other countries. So there’s a fair chance that you’ll find a branch not far from you. For a HELOC, the bank is currently offering a 12-month introductory rate of 2.990%. The rate rises to 4.430% after the introductory period.
Wells Fargo. The world’s second largest bank by market capitalization, Wells Fargo is also the leading mortgage lender in the U.S. In 2016, the bank issued $249 billion in residential mortgages for a market share of 13%.
For a HELOC, Wells Fargo offers rates from 4.25% to 9%. The bank also has fixed rates for HELOCS, and recently instituted rate caps. It promises that the variable rate on HELOCs will never increase more than 2% annually, and that the total rate increase will be limited to 7%.
Credit Unions are member-owned financial cooperatives designed to promote thrift. Often, their loans have some of the most competitive rates and terms available. For example:
First Florida Credit Union offers 20-year HELOCs for rates as low as 4.25%. For a similar HELOC, Affinity Plus Federal Credit Union, which serves Minnesota residents, currently advertises rates as low as 4.5%.
Cash Out, Home Equity Loan or Personal Loan?
To choose the type of loan that’s best for your home improvement needs, do a basic costs-benefits analysis after asking yourself these questions:
- How much money do I need?
- How much home equity do I have?
- Can I get a better rate and/or loan terms?
- Do I have good or bad credit?
- How fast do I need the cash?
- How much hassle am I willing to endure?
If you’re a homeowner with plenty of equity but a high rate on the first mortgage, a cash-out refinance could be a great option. You might be able to finance your home renovation and lower your rate.
However, if you have very little equity or your mortgage is underwater, you may have no choice but to get a personal loan or line of credit.
Alternatively, you could apply for a no-equity-needed FHA Title 1 loan — or the FHA 203K loan if you’re buying or refinancing a fixer-upper. Keep in mind, though, that the Title 1 loan is capped at just $25,000 for single-family homes. And the 203k requires lots of paperwork and processing time.
If you have sufficient equity, and you’re happy with your current mortgage rate, it’s probably best to apply for a home equity loan or a HELOC. No use in messing with your current mortgage rate if it’s already very low. Just add a HELOC on top of it instead.
Already buying or refinancing, but want to tack on the money needed for renovations. Choose the FHA 203k or Fannie Mae Homestyle loans. Or, if you’re a veteran looking to make your house more energy efficient, look into the VA Energy Efficient mortgage.
If you have bad credit, you still have options, but not as many options as those with good credit. A government-backed refinance may be your best bet. Otherwise, you’ll have to hope that you qualify for a personal loan with a reasonable rate (or can pay the loan back quickly).
The lower your credit score (assuming little or no home equity), the higher the odds that you’ll have to make trade-offs when it comes to home improvement financing. For example, you might need to accept a smaller loan in exchange for a lower rate, or put up collateral (such as a car) to obtain a larger loan at a reasonable rate.
The Best Way to Finance Home Improvements
When it comes to any loan, the #1 Rule is always shop around!
Although it’s not a bad idea to start with a quote from the bank that issued your first mortgage, don’t stop there. Research current interest rates and terms, as well as closing costs and the other fees associated with different loans.
Don’t limit your research to interest rates. Otherwise, you might end up comparing apples to oranges.
Just because a lender has the lowest rate on (say) a cash-out refinance doesn’t mean it is offering the least-expensive option. It’s not uncommon for lenders offering low rates to tack on higher closing costs and other fees than the competition. In you’re not careful, you could pay more for a loan with the “lowest” rate.
Depending on the type of loan for which you’re applying, you should also:
- Make sure the loan doesn’t include a balloon payment — a lump sum that is due before the loan is paid off.
- Check the terms of the draw and repayment periods (for HELOCs). How much time do you have to withdraw money before the loan becomes fully amortizing? By how much will monthly payments increase once the draw period ends?
- Check rate variability. If the Federal Reserve hikes interest rates by x percentage points, how would that impact your ability to make the monthly payments? A 0.25% Fed rate hike raises your interest-only payment by $5 per month per $25,000 borrowed. Is there an option to convert the loan to a fixed rate?
- Be sure to borrow enough. Home improvement projects, especially big ones, are notorious for cost overruns. Therefore, you may want borrow more than you think you need to give yourself some “wiggle room.” Few things are worse than having to stop work midway through a home renovation project because the money dried up.
- Check your credit score before applying for a loan. Lenders always charge higher rates to people with lower credit scores.
If you’d rather spend eternity on a hamster wheel than do the legwork needed to locate the right loan, consider an online service such as LendingTree.
Despite its name, LendingTree is not a lender. It’s a loan facilitator. After filling out an application on its site, the company uses a computer algorithm to match you with different lenders in its network. So instead of pounding the pavement and surfing the web to find a lender with the best offering, lenders contact you with their quotes.
It’s one of the fastest, most convenient ways to comparison shop.
Based on a sampling of customer reviews, however, it’s obvious that LendingTree is a service that people either love or hate.
While some customers praised the company’s customer service and the speed with which they received multiple offers, others complained that they were deluged with calls from lenders — calls that just wouldn’t stop.
Alternatively, you can shop for a home improvement loan on this website. We can put you in touch with a lender that offers any kind of cash-out loan or 203k loan. They may even have a source for personal loans and home equity loans and lines of credit. Click here to start>>
Best and Worst Home Improvement Projects
Before you consider home renovation financing, consider your long-term goals for the home improvement project you have in mind.
Are you undertaking the work for yourself — e.g., because you’re a “master chef” who’s always needed a ginormous kitchen island? Or do you simply want to increase the home’s resale value when you put it on the market in six months?
You’ve probably heard that certain improvements can increase the resale value of a home.
What you may not have heard is that you will almost never recapture 100% of the money you invest in a remodeling project. Spending $50,000 to install a backyard patio doesn’t mean that you’ll receive an extra $50,000 when you sell the house.
In fact, according to Remodeling’s 2017 Cost vs. Value Report, the only type of home improvement that returns more than the original investment is installing fiberglass insulation in the attic. The average return on investment (ROI) for this improvement is 107.7%.
Home improvement projects with the best average ROIs nationwide include: entry door (steel) replacement (90.7%); manufactured stone veneer (89.4%); minor kitchen remodeling (80.4%); garage door replacement (85%); and siding replacement (76.4%).
Some of the worst home improvement projects in terms of average ROI include: a bathroom addition (53.9%); installing a backyard patio (54%); major and minor bathroom remodeling (59.1% and 64.8% respectively); and major kitchen remodeling (61.9%).
Based on these statistics, it seems that “less is more” when it comes to increasing your home’s value via home improvements.
So before you start tearing down walls, hoping to make a killing in the real estate market, do a little homework.
Many renovations do increase a property’s value. However, the vast majority of home improvements do not pay for themselves once the house is resold.
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