Remodeling your home can be pricey, but home remodel loans can help. While there are no specific loans for home remodeling, homeowners have some options to choose from to finance renovations. From home equity loans to cash-out refinance options, understanding your financing choices can help you find the best home improvement loan for your next project.
Home Remodel Loan Options: Guide for Homeowners
Home equity loans, home equity lines of credit and personal loans are all examples of loans for home improvement. Learn what home improvement loan options you have and the pros and cons of each.
Updated: October 18, 2024
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Key Takeaways: Loan Options
A lump sum you borrow against the equity you’ve earned on your home and can use for any purpose.
A line of credit you have access to that is based on your home’s equity. You can borrow only what you need for almost any purpose, including home renovation.
A loan offered by the Federal Housing Administration that is meant specifically to fund a home’s purchase or repair.
A mortgage refinance that lets you cash out equity for any purpose.
A flexible loan you can use for almost any purpose, which may or may not require collateral.
How Do Home Remodel Loans Work?
A home remodel loan or home improvement loan can be any type of financial product that allows you to fund your renovation. There are several types of loans for home improvement, such as home equity loans, home equity line of credit (HELOCs), personal loans, cash-out refinance and FHA rehab loans. These can be offered by banks, credit unions, online lenders and, for FHA rehab loans, the Federal Housing Administration.
Each home improvement loan option may have varying loan amount limits, interest rates, repayment terms and more — which can change depending on the lender’s requirements and your financial history. Likewise, the application requirements between products and lenders will differ.
If approved, you can use your loan to finance a range of activities, such as:
- Repairing your home
- Remodeling a room or several rooms
- Adding a new structure to your home
- Renovating your home
- Replacing systems in your home (electrical, plumbing, etc.)
Home Equity Loans
A home equity loan uses your home's value as collateral, letting you borrow a lump sum equivalent to some of your home’s equity. You can use the loan for a number of reasons — home renovation included. It’s a good option for long-time homeowners who have built significant home equity.
Lenders may offer you up to 80% to 85% of the value of your home. It comes with a fixed interest rate, which makes repayment easier to anticipate. However, the total amount lent to you, along with the loan term, interest rate and other details, will depend on your home’s equity, your financial history and additional financial factors.
Home equity loans also come with various fees, but not all lenders may charge them. You may be asked for an application fee, appraisal fee, notary signing services, title search and insurance or flood certificate, among others.
Pros and Cons of Home Equity Loans
- Easy to qualify: It’s easier to qualify for a home equity loan than a mortgage.
- Tax-deductible: The IRS may allow you to deduct the interest you pay from your taxes.
- Low-cost option: It’s a lower-cost alternative than credit cards, as home equity loans have lower interest rates.
- Flexible use: It can be used for almost any purpose, similar to a personal loan.
- Fixed interest: It comes with a fixed interest rate.
- Risk of foreclosure: It uses your home as collateral, so you can lose your house if you cannot repay the loan.
- High rates: It has higher rates than a mortgage.
- Difficult to qualify: It may be difficult to qualify, as there are thresholds for credit scores and home equity.
Home Equity Line of Credit (HELOCs)
A home equity line of credit (HELOC) is similar to a home equity loan in that you borrow against your home’s collateral. However, with a HELOC, you only borrow what you need when you need it. It’s similar to a credit card, but you can use your HELOC by writing a check, swiping a debit card tied to the account, or transferring funds to your account.
Taking out a HELOC typically requires you to have at least 15% of your home’s equity. However, there’s no guarantee that you will be granted the maximum equity you’ve earned on your home. Lenders will still evaluate your credit score, debt-to-income (DTI) ratio and other financial factors to determine your loan amount, interest rate and terms. It’s a good option for homeowners who have earned equity in their homes and do not want to take out a lump sum.
With a HELOC, the interest rate is often variable, which means it’s subject to change. Lenders can cap how long you can borrow money, such as five or ten years. Once this period is over, you may be required to pay in full or over time under a repayment period.
Pros and Cons of HELOCs
- Higher borrowing amount: As your HELOC is based on your equity, you have potential access to a higher loan amount than other home improvement loan options.
- Use it for anything: You can use a HELOC for almost any purpose, including remodeling your home.
- Tax-deductible: If your home improvements increase the value of your home, you may be able to deduct the interest from your taxes.
- Flexible use: As a HELOC is a line of credit, you only incur debt from what you spend, unlike needing to pay off a lump sum that you may not use in full.
- Lower interest: Compared to actual credit cards, HELOCs often come with a lower interest rate.
- Variable interest: A variable interest rate means your monthly repayments may fluctuate.
- Potential for balloon payment: Some HELOCs may require you to repay your balance in a lump sum, which can be difficult if you don’t have the cash on hand.
- Risk of foreclosure: A HELOC uses your home as collateral, which puts it at risk of foreclosure if you cannot repay.
FHA Rehab Loans
Also known as a 203(k) loan, FHA rehabilitation loans offer homebuyers and homeowners the ability to finance home improvement or renovation projects up to $35,000 through their mortgage for a limited 203(k) loan. To get an FHA rehabilitation loan, borrowers must furnish a downpayment of at least 3.5%, making it a good option for borrowers with low credit or who can only afford a small down payment.
There are two types of FHA 203(k) loans: standard and streamlined. Standard 203(k) loans are for extensive repair or substantial structural work, while Streamlined 203(k) loans are for less extensive home improvement projects.
FHA 203(k) loans have fewer eligibility requirements and qualifications than regular mortgages, as they are backed by the Federal Housing Administration. Since the government guarantees and insures the loan, lenders are more willing to take on risk. Additionally, the borrower may choose a fixed-rate mortgage of 15 years or 30 years, or an adjustable-rate mortgage (ARM).
Pros and Cons of FHA Rehab Loans
- Government-backed loan: these loans are insured by the FHA, making them easier to qualify for.
- Small downpayment requirement: The 3.5% down payment requirement makes it more accessible for individuals with low credit or who can only afford a small down payment.
- Low interest: As a government-backed loan, FHA rehab loans often have lower interest.
- Use for purchase or renovation: The 203(k) loan can be used for purchasing a home, renovating a home or both.
- Temporary housing: If your home needs serious repairs, an FHA 203(k) loan can provide temporary housing while your home is under renovation.
- Down payment required: Unlike other loan types, an FHA rehab loan requires a down payment.
- Requires mortgage insurance premium (MIP): All FHA loans require MIP, which can protect the lender if you default.
- Lengthy application: Getting an FHA rehab loan may take a while, as the application process is lengthy.
Cash-Out Refinance Options
Cash-out refinance takes advantage of the equity you’ve built in your home, allowing you to refinance your existing loan with a larger one to receive extra cash from the lender and repay your initial mortgage. The additional money can be used for almost anything, such as renovations or repairs. It’s a good idea for homeowners who can qualify for a better interest rate if they refinance.
A cash-out refinance can be obtained through banks, the FHA, or the Veterans Administration (VA). Your requirements, interest rate, loan amount, and more can vary depending on the lender.
Pros and Cons of Cash-Out Refinance Options
- High loan amount: Since you are using your home’s equity, you may be offered a higher loan amount than you need.
- Long repayment period: Refinancing a mortgage can last as long as a typical mortgage, 15 years or more.
- Tax-deductible: If you use some of your additional funds to improve your home and increase its value, the interest may be tax-deductible.
- Flexible use: You can use the funds for almost any purpose — renovation, repairs, remodeling and more.
- Potential to get a lower interest rate: Refinancing is typically done to get a lower rate. If you have a better credit score than before, you may qualify for a better rate.
- Foreclosure risk: A cash-out refinance loan also uses your home as collateral. If you cannot repay your loan, you risk losing your home.
- More interest: As you reset the clock on your mortgage by replacing it with a new one, you will have to pay more in interest over the life of the loan.
- Costly closing fees: Taking out a new mortgage means new closing fees, which can be costly.
Personal Loans
A personal loan is a lump sum you can borrow from banks, credit unions and online lenders to use for almost any purpose. Home renovation, remodeling and repairs are just a few things you can do with a personal loan. A personal loan may be a good fit if you’ve just bought your home and haven’t built equity yet.
Unlike the other options mentioned above, a personal loan does not rely on your home’s equity. Instead, lenders will determine your loan amount, interest rate and repayment terms based on your creditworthiness, debt-to-income (DTI) ratio and other financial factors. However, you can typically choose between a variable or fixed interest rate, depending on the lender.
Personal loans are repaid monthly, with the amount due stated in your agreement. If you’re late with your payments, you may need to pay a late payment fee. If you fail to repay it entirely, your lender may sue you if your loan is unsecured, or they may take away your collateral if it is secured.
Pros and Cons of Personal Loans
- Flexible use: Personal loans can be used for almost any purpose, such as home renovation, debt consolidation and more.
- No collateral: An unsecured personal loan does not require any collateral, which means no risk of losing any of your assets.
- Easier to qualify: Compared to credit cards or other types of loans, it may be easier to qualify for a personal loan, as some home remodel loans require equity.
- Manageable repayments: It is easier to repay a personal loan than a credit card or payday loan. There are a variety of repayment terms available, ranging from 24 to 60 months or more, depending on the lender.
- High borrowing limits: Personal loans often have higher limits than credit cards.
- May require collateral: With a secured personal loan, you may be required to put up collateral, such as your car or another valuable asset.
- Increases debt: On top of paying for your mortgage, adding a personal loan to the mix can be challenging if you do not watch your finances closely.
- Potential high interest rates: If you do not have good credit, you may be given a high interest rate.
FAQs About Home Remodel Loans
We answer frequently asked questions about home remodel loans to help you find your best option.
When should I take out a home remodel loan?
If you can repay a loan and want to remodel your home, then taking out a loan for home improvement may be a good option. The type of loan you get will depend on your home’s equity and your capability to repay.
What credit score do I need to get a home improvement loan?
It depends on the type of loan. With an FHA rehabilitation loan, you may only need to meet the down payment requirements. However, with something like a personal loan, you may need to meet the lender’s credit requirements to qualify. A loan based on your home’s equity may require both personal financial history and equity built into your home.
How does the lender determine the "after-renovation value"?
The lender may ask an appraiser to determine the after-renovation value, using the estimated cost of your home as a basis and adding the estimated value of your renovation.
Do you need a construction plan before applying for a home remodel loan?
No. Most home remodel loans can be used for other purposes, so you will not need to prove your plans to be approved.
What is the average interest rate on home remodel loans?
It depends on the home remodel loan. As all home improvement loans are different financial products that you can use for different purposes, they also have different requirements, interest rate averages, terms and more.
Learn More About Home Loans
sources
- Federal Register. "Request for Information Regarding Rehabilitation Mortgages." Accessed October 15, 2024.
- IRS. "Real Estate (Taxes, Mortgage Interest, Points, Other Property Expenses) 2." Accessed October 15, 2024.