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If you’re planning on becoming a homeowner, be prepared to spend a ton of money. As of May 2018, the average new home in the U.S. costs $368,500, reported the Census Bureau. If you can’t afford the price of a new house, you might have to turn to a fixer-upper to stay within your budget.
However, buying a cheaper home that needs repairs can be costly, too. If you want more complex changes, such as changing the cabinets in the kitchen or installing a new bathroom, your renovations can cost thousands. While paying cash is ideal, that idea is unrealistic for most young people just starting out.
Home improvement loans can help make your remodeling dreams come true. But before you sign your name on a loan application, make sure you understand what you’re getting into.
What are home improvement loans?
It’s important that your house is comfortable and works for your family needs. If it doesn’t, it can lead to a lot of stress. For example, if you have several children but only one bathroom, getting the whole family showered and ready for school and work can seem downright impossible.
If you want to put in a new bathroom, install solar panels, or just need new furniture, a home renovation loan can be exactly what you need to complete your projects.
There are several types of home improvement loans and financing options:
1. Home equity loan
A home equity loan is when you borrow money using your house’s equity as collateral. Your home equity is the difference between your home’s value and what you’ve paid toward the mortgage.
For example, if you just purchased a $200,000 home and made a $20,000 down payment on the loan, your home’s equity is just $20,000 and you owe $180,000 on the home.
However, your home’s equity can increase as you make mortgage payments and if the house’s value increases. If your home’s appraised value grew to $220,000 and you paid $10,000 toward your mortgage, you would have much more equity.
With a home equity loan, you can borrow a percentage of the equity in your home. Depending on the lender, you could borrow as much as 85 percent. If your equity was $50,000, that means you could borrow up to $42,500.
Because you are using your home as collateral, interest rates for equity loans tend to be lower than other loan types. However, that can also be a problem. If you can’t keep up with your payments and default on your loan, your lender might foreclose on you and you could lose your home.
In addition, if home values decline and you owe more on your home than it’s worth, a home equity loan isn’t an option.
You can apply for a home equity loan with most banks or credit unions. The length of repayment can vary from lender to lender but typically is between five and 20 years.
2. Title I Property Improvement loan
If your home doesn’t need extensive repairs, a Title I Property Improvement loan can be a great option.
With this type of home renovation loan, the Federal Housing Administration (FHA) insures loans made by lenders to borrowers like you. If you default on your loan, the FHA’s insurance covers up to 90 percent of the loan, so there’s less risk for lenders.
You can borrow up to $25,000 if you’re using it for a single-family home, or $12,000 if you’re using it for an apartment or townhouse. Depending on the type of home you have, your repayment term could be 12 to 20 years.
The FHA does not determine interest rates. Instead, the loan’s rate can vary based on the lender and your location.
The FHA also charges an annual premium of $1 for every $100 you borrow. You pay for the insurance through a separate monthly bill, or it can be charged as a higher interest rate on your loan.
If you take out a loan for more than $7,500, you’ll need to secure the loan with your mortgage or deed of trust on the property.
Only financial institutions approved by the U.S. Department of Housing and Urban Development (HUD) can offer Title I Property Improvement loans. You can use HUD’s locator tool to find a lender near you.
3. Unsecured home improvement loan
If using your home as collateral scares you, there’s another way to get the money you need. Some banks offer unsecured home improvement loans to help you pay for repairs. Even better, they don’t require you to offer up your home or other assets as a guarantee. If you default on your debt, the lender can’t take your house from you.
Depending on the lender, you could borrow up to $100,000 and get the funds quickly. However, there are some drawbacks with going this route.
For one, the repayment term is usually much shorter than the terms for home equity loans or the Title I Property Improvement loan. Unsecured home improvement loans can have repayment periods as short as two years.
While an unsecured loan can give your home more protection, you will pay a premium for that security. With higher rates, you could pay thousands more over the length of your loan.
For example, if you took out a $20,000 home equity loan at 3.99% interest with a five-year term, you’d pay back just $22,094 in total. However, if you took out an unsecured loan at 35% interest over five years, you’d pay back a staggering $42,588.
Also, unsecured home improvement loans are typically not eligible for interest deductions when tax season arrives; both home equity loans and Title I Property Improvement loans usually qualify.
If you can only get a loan with a high interest rate, it might be worth waiting until you have more equity in your home before borrowing.
4. Credit card
If you have a credit card with a high credit line, you might be tempted to use it to fund your home improvement project. However, doing so can be a costly mistake. According to the Federal Reserve, the average interest rate on credit cards is over 15.00%. Such a high rate means you’ll pay far more than you originally charged thanks to interest charges. Your balance can quickly grow out of control, making it difficult to pay it off.
5. Personal loan
Another option to consider is applying for a personal loan. Unlike some other forms of home improvement loans, personal loans are unsecured. That means they don’t require any form of collateral, so there’s less risk associated with them. Plus, those with good credit can qualify for low-interest personal loans.
However, unless you have excellent credit and a stable income, you might pay a price for the convenience of a personal loan. If you have poor credit, you could end up with interest rates as high as 200%, making a reasonable home repair prohibitively expensive.
If the only way you can afford a home repair is to take out a pricey personal loan, it’s a good idea to wait until your credit improves or you can save up the money to pay for the home improvements in cash.
Finance home improvement jobs carefully
Before applying for home improvement loans, make sure you have a plan and budget in place to repay what you borrow.
Those new granite countertops or stainless steel appliances will seem far less attractive when you’re strapped for cash and can’t afford your payments. Knowing what you can truly afford can help you enjoy the renovations guilt-free.
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