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The Six Types of Home Improvement Loans
We thoroughly compared each option in our home improvement loans article. As a result, this section won't dive deeply into each option but will provide resources to learn more. However, this section will discuss how the payment structures vary with each option and why you might prefer it.
- Home Equity Line of Credit
A HELOC is the best option if you're unsure when to begin improvements or want an emergency repair fund. HELOC interest rates are typically low, and lenders don't charge interest on any unused amounts. You won't have to pay anything if you leave money sitting in your HELOC balance. Any withdrawn amount will accrue interest.
Additionally, HELOCs can have up to a 15-year interest-only period. This means you can make minimal interest-only payments while this period lasts. Selling your house before this period ends will increase your return on investment because you'll have lower upfront costs. After this period ends, you won't be able to withdraw more and must make complete payments of principal and interest.
- Home Equity Loan
A home equity loan is best if your primary mortgage has low-interest rates and you want to begin improvements immediately. Similar to a HELOC, this acts as a second mortgage which won't impact your primary mortgage rates.
However, the difference from a HELOC is that you can't withdraw and repay as needed. Instead, you receive the total amount upfront and must make payments immediately. We have a thorough article comparing a HELOC vs home equity loan.
- Cash-Out Refinance
A cash-out refinance is best if you want to make changes to your mortgage and want to undertake significant improvement projects. This option replaces your existing mortgage with a larger balance and gives you the difference in cash.
As a result, you'll need to make payments on the borrowed amount immediately. However, if you refinance into lower interest rates, your payments may decrease or stay the same. There is also the option to keep payments low by extending your mortgage amortization. You can use a cash-out refinance calculator to see how your payments will change. Overall, this option typically has the lowest interest rate but the highest upfront fees.
- Personal Loans
Personal loans are best if you want to make more minor repairs or don't have equity in your home. The interest rates can vary greatly depending on your credit score, but they often have lower fees and quicker approval times than other options.
There is also the option for a personal line of credit. This works similarly to a HELOC with the ability to withdraw and repay as needed, but there may be lower limits on how much you can borrow. Additionally, the interest rate will be higher.
- Federal Programs
Federal programs, such as a 203k loan or energy-efficient mortgage, may have lower interest rates and specific eligibility requirements. However, they also have longer approval times, and stricter funds use guidelines.
- FHA 203(k) Loan: This option allows you to roll home improvement costs into your mortgage. The loan is available for both purchases and refinancing, but there are specific eligibility requirements and restrictions on the improvements that can be made.
- Energy-Efficient Mortgage: This option allows you to increase your mortgage balance to make energy-efficient improvements to your home. You must meet specific energy efficiency and income requirements for eligibility.
- Credit Cards
Using a credit card for home improvement costs can be an option if you have a low-interest rate and the ability to pay off the balance quickly. However, it's essential to consider the potential for accruing high-interest rates and fees if you cannot pay off the balance promptly.
Only some contractors and merchants will accept credit cards. It is possible to pay them cash with a credit card, but it will accrue cash advance fees. If you can pay through the card, you can eventually use a balance transfer card. These have low-interest promotional rates for a three to 12-month period. After the period ends, your APR will increase to the standard credit rate, which typically exceeds 20%.
Comparing Home Improvement Loans
- Interest Rate: Secured loans have lower interest rates but foreclosure risks if you miss payments.
- Term Length: Longer-term lengths will reduce your monthly payment but increase the lifetime interest paid.
- Borrowing Structure: Most options provide a lump-sum deposit that accrues interest immediately. However, a line of credit won't charge you for any unused amount.
- Payment Structure: Some options have an interest-only period, while others require you to make principal and interest payments.
- Funding Speed: Some options, such as personal loans and credit cards, have quicker approval times but may come with higher interest rates. Federal programs often have longer approval times but potentially lower interest rates.
- Fees: Secured loans have higher upfront fees but typically lower interest rates. Personal loans and credit cards may have low or no upfront fees but higher interest rates.
Bottom Line
There are many options for financing your home improvement projects. Consider the interest rate, fees, and eligibility requirements to determine which option is best for you and your project. And remember to use a home improvement loan calculator to estimate your monthly payments and overall cost.
Remember always to borrow responsibly and within your budget. With careful planning and intelligent decision-making, your home improvement projects can be a success.