Home improvements can get pricey. Just redoing your kitchen can cost between $10,000 and $30,000, according to the True Cost Guide from HomeAdvisor. Even building a deck costs, on average, more than $7,000.
If you’re going to make those sorts of home improvements, you’ll probably need a loan. When it comes to home improvements, most people decide on a HELOC versus a personal loan.
Here’s what you need to know to make your decision.
HELOC vs. personal loan: What’s the difference?
Figuring out the difference between a HELOC and a personal loan — and, more important, which works best for your situation — is a challenge. There are a few main points you should know about each option that might help as you plan your next home renovation.
HELOC: The basics
A HELOC, or home equity line of credit, requires that you use your home as collateral to secure the loan.
If you default on your HELOC, the lender has the option to repossess the house. You’re also limited by the amount of equity — or ownership — you have in your home, so if you haven’t built much equity in it, you might not be able to get a HELOC.
One advantage to a HELOC is that it’s a revolving line of credit. As you make payments, you free up more room to borrow again without going through the application process. The interest you pay on your home improvement HELOC can be deducted when you file your tax return.
How a personal loan works
A personal loan, on the other hand, is unsecured.
If you default on a personal loan, a lender can sue you, but it usually can’t take your home. Additionally, with a personal loan, it’s possible to borrow as much as the lender is willing to risk, without worrying about whether you’ve built up value in your home.
But you should realize a personal loan has a fixed term, so if you need more money, you have to reapply for a loan. Plus, you can’t deduct the interest for home improvements made with a personal loan on your taxes.
|HELOC vs. personal loan for home improvements|
|Credit check required||Yes||Yes|
|Maximum loan amount||Depends on available equity||Varies|
|Option for revolving credit||Yes||No|
5 questions to ask when deciding on a HELOC vs. a personal loan
When figuring out which type of loan best suits your needs, think through your situation. The following questions can help you decide how to proceed.
1. How much money do you need?
Your first consideration is how much money you actually need to complete your home improvement goals.
For example, say you have a home worth $250,000. You still owe $190,000 on it. The lender is willing to finance you up to a combined LTV of 80%. So, the amount of your combined first mortgage and HELOC can’t exceed $200,000. That only leaves you with $10,000 in available equity to borrow against.
While it’s possible to find some lenders willing to finance to a higher combined LTV, said Hensel, you still might not have enough equity in your home to borrow what you need to complete the project.
The longer you’ve been in your home, paying down the mortgage, the more equity you have available to you.
If you don’t have enough equity to fund your project, you might be able to qualify for a personal loan large enough to cover your costs — without putting your home at risk. With a personal loan, you might be able to borrow up to $100,000 depending on your credit and income situation.
If you have a lot of equity in your home, but you have only fair credit, you might be able to get a bigger loan with the HELOC.
2. Do you want flexibility?
An advantage to a HELOC, Hensel pointed out, is the fact that you have more flexibility in how much you borrow — and how much interest you pay.
“You’re only charged interest on the amount of funds currently borrowed against the credit line,” Hensel said. “When you deposit funds back into the credit line, the interest stops accruing on that amount.”
Compare that to a personal loan, where you have a set payment schedule and interest is constant.
On top of that, if you discover the home improvement project is taking longer and costs more than you expected, you might have a hard time getting another personal loan.
With a HELOC, you only take what you need, as you need it. As long as there’s room on the credit line, you can get more money without applying for another loan.
“A HELOC is similar to a credit card,” said David Reiss, a real estate finance professor at Brooklyn Law School. “This can make sense for a homeowner with a seasonal need for credit.”
Because a HELOC can remain open for several years, said Reiss, it’s ideal if you know you’ll have ongoing home improvement expenses.
3. How fast do you need the money?
When you need money fast, a HELOC might not be the way to go. Getting approved for a HELOC can take weeks, according to John Harris, executive vice president of sales and marketing at EnerBank USA, a specialty bank providing unsecured home improvement loans.
With an unsecured personal loan, it’s possible to receive a decision in minutes, Harris said. Not only that, but you can receive funds as early as the next business day.
4. What interest rate can you get?
“With mortgage rates on the rise, the rates on an unsecured loan can be lower than a home equity loan,” said Harris.
While much depends on your credit and income situation, Harris said, the current low-interest environment offers an opportunity for borrowers who want to qualify for the best rates on home improvement loans.
As of May 23, 2018, the national average rate on a $30,000 HELOC is 5.85%, according to Bankrate. But it’s possible to get a personal loan for as little as 4.99%.
Using our personal loan calculator, you can compare the final (principal and interest) cost of a five-year, $30,000 loan at those rates.
If you qualify for the best rate on a personal loan, you could potentially save $714 on interest by choosing a personal loan over a HELOC.
5. Do you want the tax deduction?
Of course, one of the main reasons in choosing a HELOC versus a personal loan is the tax deduction. As long as you use the money you borrow with a HELOC to make improvements to your home, you can deduct the interest you pay on your taxes.
Depending on your tax bracket and the amount of interest paid, the deduction could offset a higher interest rate. Consider a $30,000 HELOC at 5.85% over five years. Here’s what the savings in your first year could look like using Bankrate’s mortgage tax deduction calculator, based on your tax bracket and by assuming a state tax rate of 7%:
- 10% bracket: $312 (effective interest rate 4.90%)
- 12% bracket: $348 (effective interest rate 4.79%)
- 22% bracket: $526 (effective interest rate 4.24%)
- 24% bracket: $561 (effective interest rate 4.14%)
- 32% bracket: $704 (effective interest rate 3.70%)
- 35% bracket: $757 (effective interest rate 3.54%)
- 37% bracket: $793 (effective interest rate 3.43%)
But you must itemize your deductions to take the deduction, and it’s more valuable the higher your tax bracket.
For some borrowers, even paying a higher interest rate on a HELOC could be worth it for the tax savings.
HELOC vs. personal loan: Next steps
When deciding on a HELOC versus a personal loan, consider what works best for you depending on your situation and your goals for the home improvement loan.
Compare rates and terms, and run the numbers to see what would work best for you — while providing the type of flexibility and time frame you need.
Compare home equity loan offers
Interested in a personal loan?Here are the top personal loan lenders of 2018!
|Lender||APR Range||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Includes AutoPay discount. Important Disclosures for Payoff.
3 Important Disclosures for FreedomPlus.
4 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
5 Important Disclosures for LendingPoint.
6 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage & history. The APR ranges from 6.16% to 35.89%. For example, you could receive a loan of $6,000 with an interest rate of 7.99% and a 5.00% origination fee of $300 for an APR of 11.51%. In this example, you will receive $5,700 and will make 36 monthly payments of $187.99. The total amount repayable will be $6,767.64. Your APR will be determined based on your credit at time of application. The origination fee ranges from 1% to 6% and the average origination fee is 5.49% as of Q1 2017. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months or longer.
7 Important Disclosures for Earnest.
8 Important Disclosures for Avant.
* The actual rate and loan amount that a customer qualifies for may vary based on credit determination and other factors. Funds are generally deposited via ACH for delivery next business day if approved by 4:30pm CT Monday-Friday. Avant branded credit products are issued by WebBank, member FDIC.
** Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
** Accept your loan offer and your funds will be sent to your bank via ACH within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes this transaction. From the time of approval, funds should be available within four (4) business days.
|7.73% – 29.99%||$1,000 - $50,000||Visit Upstart|
|6.26% – 14.87%1||$5,000 - $100,000||Visit SoFi|
|6.99% – 35.97%*||$1,000 - $50,000||Visit Upgrade|
|8.00% – 25.00%2||$5,000 - $35,000||Visit Payoff|
|4.99% – 29.99%3||$10,000 - $35,000||Visit FreedomPlus|
|5.99% – 18.99%4||$5,000 - $50,000||Visit Citizens|
|15.49% – 34.49%5||$2,000 - $25,000||Visit LendingPoint|
|6.16% – 35.89%6||$1,000 - $40,000||Visit LendingClub|
|6.99% – 18.24%7||$5,000 - $75,000||Visit Earnest|
|9.95% – 35.99%8||$2,000 - $35,000||Visit Avant|