6 Options For Your Home Improvement Loan
Investing in home improvements can be beneficial in several different ways. First, home improvements can greatly improve the function or look of your home, and improving your enjoyment of it. Secondly, home improvements may address a serious issue that your home has, such as a safety or security issue. Lastly, home improvements can add value to your home and increase your equity. However, home improvements can cost thousands–sometimes even tens of thousands–of dollars. This usually means you’ll need to take out a home improvement loan.
Home improvement loans can be a challenge to obtain. If you run into financial trouble, odds are you’ll prioritize your initial mortgage over the home improvement loan, making it a bigger risk for lenders to approve such a loan. As such, higher credit scores are generally required. However, there some alternatives that you can apply for to secure the money you need to make a home improvement.
Alternative Home Improvement Loans
Six different home improvement loans to look into if you’re planning home repairs, renovations, or remodels are detailed below:
1. Home Equity Line Of Credit (HELOC)
A HELOC loan is provided in the form of a line of credit. When you take out a HELOC loan, you’re taking out a loan against the equity you have in your home. This means that you’re using your home as collateral for the loan. It’s basically a second home mortgage, which means that you will be responsible for paying both your current mortgage and HELOC loan payments on top of that. Here are a few things you should know about HELOC loans:
- You only make payments on the money that you’ve withdrawn from your line of credit. For example, if you have a $20,000 line of credit and you take out $10,000, you’ll begin making payments on that $10,000 every month until you’ve paid it off.
- Any payments you make go back towards your line of credit. For example, if you’ve used your entire $20,000 line of credit and you’ve paid back $5,000, then you now have $5,000 in your line of credit available to withdraw from.
- You only pay interest on what you withdraw. If you’ve only used $5,000 of a $20,000 line of credit, then you’re only paying interest on that $5,000.
- Interest rates on HELOC loans are typically variable, which means that they can go up and down depending on the market. Most states do cap HELOC interest rates at 18 percent.
- You can only take out up to 80 percent of the equity you have in your home.
- You’ll generally need a debt-to-income ratio of no more than 43 percent.
- You will need a credit score of at least 620.
- You must have a good credit history (meaning that you pay your bills on time and don’t have any recent blemishes on your credit report, such as foreclosures or collections).
- Your lender can change your agreement (meaning, they can alter your line of credit) if conditions change. They can even freeze your line of credit.
- Most HELOC loans come with annual fees as well as cancellation fees.
- Most HELOC loans have withdrawal periods that last between five and 10 years. You usually have up to 20 years to repay depending on the terms.
- HELOCs require a minimum withdrawal amount, meaning that you can’t make small withdrawals whenever you need to (it’s not like a credit card).
HELOC loans can be very beneficial if you’re planning multiple renovations over the course of a longer period of time since you don’t have to take out a large sum all at once.
2. Cash-out Refinance
A cash-out refinance is a type of mortgage refinance loan, requiring that you refinance your current mortgage; however, instead of borrowing what you need to pay off your current balance, you’ll borrow more than what you need. Once the balance of your initial mortgage is paid off, the difference goes to you in straight cash. You can then use this money to fund your home improvement project. The loan replaces your old mortgage, which means you’ll just pay it back on a month-to-month basis like you would any mortgage. The following are a few important things to keep in mind:
- You need to have at least 20 percent equity in your home.
- Requirements will be similar to that of your initial loan, which means you’ll need to provide proof of income, an adequate debt-to-income ratio (usually no more than 43 percent), and a good credit score (usually a minimum of 620 to 640) to be eligible and to qualify for good terms.
- You cannot receive a loan larger than the value of your home. Most lenders won’t approve a cash-out refinance of more than 85 percent LTV even if you have more than 85 percent equity in your home.
A cash-out refinance can be quite beneficial if you need a large sum of money and you’ve built some equity in your home. It’s especially beneficial if the terms on your existing mortgage aren’t great and you’ll qualify for lower interest rates when refinancing. However, if the interest rates will be higher, it may not be worth doing a cash-out refinance.
3. Credit Cards
Instead of taking out a loan, you can also apply for a credit card and put the costs of a home improvement project on it. Although a higher credit score is required, other requirements are much more lenient. For example, although you need to report your income, you don’t need to show proof of income. The following are a few things you should know about using a credit card for home improvements:
- You’ll likely need a credit score of at least 700.
- Different credit cards come with different perks. Some cards may offer rewards in the form of cash back or gift cards that can be helpful for your home improvement project.
- Interest rates are generally much higher than standard loans. If you’re not careful, you can pay a significant amount of money in interest. Depending on your credit score, the APR on a credit card can range from 15 to 25 percent.
- Some credit cards do have annual fees.
- The line of credit can be limited on a credit card. A lot of factors go into determining how much credit is made available to you, including your income and credit score. A credit card may not be able to cover a substantial remodeling project.
- If you use the entire balance of your credit card, it can damage your credit score. The general rule of thumb is to keep your balance below 30 percent to ensure that your credit score doesn’t take a hit.
Credit cards are better suited for minor home improvement projects due to their high interest rates and the limited amount usually available. They are a good option for smaller projects if you can pay it back within a 12 to 18 month period. This is because many credit cards will offer low or zero APR for an introductory period. If you can pay off the card within that period, you won’t have to pay any interest.
4. Personal Line Of Credit
A personal line of credit differs from a HELOC in that it’s unsecured, meaning you don’t have to put your home up as collateral. Other than that, it functions in a similar way: you’ll be given a line of credit that you can withdraw from at any time for a certain length of time. Some details to consider about taking out a personal line of credit follow:
- Because it’s unsecured, lender requirements are much more strict. You’ll typically need a credit score of 680 or higher to qualify.
- You only pay interest on money that you withdraw from your line of credit.
- You can access your line of credit electronically or with checks.
- Interest rates are much higher than HELOC loans because they are unsecured.
- Many personal lines of credit come with annual fees.
If you’re in a good financial situation and are planning a long-term renovation project that may require incremental payments, a personal line of credit can be a great alternative. The higher interest rates they typically charge are offset by the fact that you don’t have to put your house up as collateral.
5. Personal Loans
A personal loan is provided directly from the lender to be used at your discretion. You’ll immediately begin paying back the loan on a monthly basis (in addition to interest) and will have a certain period of time to do so. There are many factors that are taken into account to determine how much you qualify for and the interest rate at which you can qualify for. Here are some of the fine points to know about taking out a personal loan to pay for your home improvements:
- Both secured and unsecured personal loans are available. If you do put up collateral for your personal loan, the interest is likely to be lower. You’ll need a stronger credit history to be eligible for an unsecured loan as well.
- You can get personal loans from a number of different lenders, including your local bank, credit unions, online lenders, consumer finance companies, and even peer-to-peer lenders.
- Interest rates vary widely based on your credit report, your income, whether it’s secured or unsecured, and more. They can be as low as five percent or as high as 36 percent.
- Lenders often charge origination fees between one and six percent of the loan.
- There may be prepayment penalties included in your agreement.
Because interest rates can be very high, personal loans aren’t always the best option. However, if you need a smaller amount of money all at once, a personal loan can be useful, especially if you don’t want to take out another credit card because your credit utilization ratio is already high. Although taking out a personal loan will ding your credit score by a couple of points (due to the hard credit inquiry), it can help your score over the long term if you make your payments on time and in full. Not only are you adding on-time payments to your credit report, but you’re diversifying the type of credit you have, which can help your score as well.
6. Federal Programs
There are actually several different federal programs that can provide home improvement loans at favorable rates if you qualify for them. These types of loans are usually reserved for low-income households, rural homes, or certain demographics (such as Native Americans or senior citizens). Some common federal programs that provide home improvement loans include:
- Title I Property Improvement Loan Program – This program was created for homeowners who have limited equity in their home and can be used on improvements that make the home more livable, useful, or handicapped accessible. Luxury improvements are not included (such as building a pool or an outdoor fireplace). No collateral is required. The maximum you can qualify for is $25,000 and the maximum term is 20 years for single-family homes. The terms are a bit different for mobile homes or multi-family properties.
- Single Family Housing Repair Loans and Grants – This program is for very-low-income homeowners and is meant to be used to repair, improve, or modernize their homes. Your home must be located in an approved area to qualify and your household income must be below 50 percent of the area median income. The maximum loan amount is $20,000 and the maximum grant amount is $7,500 (these can be combined together). Interest rates are low at a fixed 1 percent and the loan can be repaid over a period of 20 years.
- VA Loans – The VA offers a number of loans that can be used towards home improvements if you qualify. VA renovation loans are basically home loans and home improvement loans rolled into one. They allow veterans to buy fixer-uppers and to make the necessary repairs and renovations. VA supplemental loans can be used to repair, improve, or alter the primary residence of a veteran (excluding luxury improvements). VA energy efficient mortgages provide home improvement loans for the purpose of improving a home’s energy efficiency (such as by upgrading HVAC systems or installing insulation). You will need to be a qualified veteran and pay 1.25 to 3.3 percent in funding fees upfront.
Federal home improvement loans can be a lot easier to qualify for and can provide favorable terms; however, you generally have to meet some kind of income or location requirements. Additionally, you can only use the funds on home improvements and those improvements cannot be for luxury features.
Factors To Consider Before Deciding On An Alternative Loan
One of the alternative home improvement loans may look like exactly what you need. However, it’s important to consider the details of each loan type to determine whether it’s a good fit for your specific financial situation. The following are some of the important factors to think through before making a decision to apply for a home improvement loan alternative:
There are two main loan types: secured and unsecured. A secured loan is generally easier to qualify for; however, this is because you will be required to put up an asset as collateral. For example, if you put your home up as collateral, then the lender can foreclose on your home if you default on the loan. As such, secured loans come with a risk. Unsecured loans do not require collateral, which means none of your assets will be taken from you if you default on your loan. However, because the lender won’t have access to collateral to help offset the risk of default, it tends to be much more difficult to qualify for. You’ll need a higher credit score, low debt-to-income ratio, and a solid credit history backing you up.
Annual Percentage Rate (APR)
While the interest rate will tell you how much interest you’ll pay on the loan, it’s more important to look at the APR. The APR includes the interest rate and the origination fees that you will owe over the course of the year. Essentially, the APR provides you with a better idea of how much taking the loan out will cost you. APRs vary from one lender to the next, so be sure to compare. Be wary of promotional interest rates. Most promotional interest rates only last for a set period of time. Once they end, they could climb significantly higher.
Look for a repayment term that best suits your needs. Consider your financial situation to determine what you’ll be able to afford on a monthly basis. Most home improvement loans are available in one, three, and five-year terms. You may be able to find a lender that can offer a longer term if needed. Keep in mind that while you’ll pay less per month with a longer the term, you will end up paying more in interest.
Different lenders may offer different benefits as a way to attract more borrowers. Compare the unique benefits that different lenders have to offer. For example, some lenders may offer repayment protections, while others may allow borrowers to use co-signers with superior credit history to qualify for a better interest rate.
Certain types of loans will require you to pay closing costs. For example, refinancing your mortgage for a cash-out will come with the same type of closing costs that you had to pay on your initial mortgage. These can be very expensive, which is why you’ll want to keep them in mind when considering the different types of home improvement loans that are available. For example, you won’t have to worry about closing costs if you’re using a credit card. Some loans will also let you roll the closing costs into the loan itself.
Getting pre-qualified for a loan is a good idea. You’ll get an idea of whether you’re actually eligible for the loan as well as how much you’re likely to qualify for. This helps you set a budget for your home improvement project, making it easier to determine the scope of your project as well as compare bids from different contractors.
Fixed-rate loans are usually considered the best option since you will know exactly how much you owe on a month to month basis over the duration of your loan term. However, if you’re looking for a shorter loan term (such as a 1-year loan), then a variable rate might be a better option. Variable rates are usually lower initially but may go up or down over the course of the loan. If your loan term is short, a variable interest rate might be the way to go since there’s less of a risk that it will go up significantly within such a short period of time. However, that risk is greater the longer the term is, which is why if you have a 5-year term or longer, you’ll probably want to lock into a fixed-rate loan.
Certain loans will be limited to your loan-to-value (LTV) ratio, such as HELOC loans or cash-out refinance loans. The LTV ratio refers to the size of the loan you’re taking out compared to the property’s value. The higher your LTV is, the more of a risk the loan is considered. If you haven’t built much equity in your home, it means that you will be more limited in the amount that you can take out using a HELOC loan.
Maximum Amount Allowed
If you’re doing major remodeling work, you may need a significant amount of money. Check the maximum amount allowed for each loan type. You might find that a personal loan or a credit card may not be enough to cover the costs of your home improvement project. However, if you have substantial equity in your home, you could qualify for a large HELOC loan, which is typically capped out at 85 percent of the equity you have in your house.
Lenders want you to pay back your loan, but they don’t want you to do it right away. The quicker you pay your loan off, the less interest they’ll make. It’s why some lenders may include repayment penalties into the terms of the loan. This means that if you pay a five-year loan off in one year, you may be forced to pay a significant penalty. Not all loans have repayment penalties (for example, you can pay off a credit card without incurring such fees), so be sure to ask about repayment penalties and what their conditions are before deciding on a loan.
Key Points Of Your Home Improvement Project
Considering how much research you’ll want to put into finding the right home improvement loan, not to mention the risk you’re taking simply by acquiring more debt to pay off, plan out your home improvement project thoroughly before you even apply for a loan. Address these three key points at the outset:
Define The Goals Of Your Projects
Make sure you know exactly why you want to invest in a home improvement project and what you’re trying to accomplish with it. For example, if you’re remodeling your kitchen, then your goals could include making your kitchen easier to use, making your kitchen more energy efficient, making your kitchen more comfortable, and improving the value of your home. Be sure to list your goals by importance as this will help you when it comes to prioritizing the different facets of the project based on the budget you have available.
Set A Budget
Figure out how much you’re willing to spend and how much you can afford to spend on your project. Keep in mind that just because you can qualify for a large loan doesn’t mean that the loan amount should equal your budget. You may not be financially comfortable enough to pay back a larger loan, after all. Once you do set your budget, it will also be easier to prioritize your wants and needs against the scope of your home improvement project.
Making Sure Contractors Use Fixed Quotes
Once you know what your goals are and what your budget is, speak to several different contractors. Do your research to find a contractor that is experienced and has a good reputation. Make sure the contractor offers a fixed quote on the project. The last thing you want is to take a quote at face value when it was only a loose estimate and have the project end up costing you more than the loan can cover. A fixed quote ensures that the project will fit your budget.
Is It Worth It?
Not all home improvement projects may be worth taking on debt for, because not all home improvement projects will actually improve the value of your property. Consider the benefits of your home improvement project and whether it will be worth the cost.
For example, if your windows are in poor shape and your energy costs are high, the investment might be worth it because upgrading your windows will improve your curb appeal (and therefore your property value) as well as your home’s energy efficiency, which will help lower heating and cooling costs. However, installing a new swimming pool can actually hurt your property value since buyers typically don’t want the headache and cost of maintaining a pool and it adds a liability risk to the property.
Of course, improving value isn’t everything. If you’re planning on living in your home for years to come, then maybe function and enjoyment take precedence over home value. These are things you’ll need to consider before you decide to take out a home improvement loan.
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