Home improvement tops many homeowners’ wish list today, with 72 percent planning at least one project in 2022. Many borrowing options are available when financing those goals, but not all possibilities are equal. Finding the best match for your needs will depend on various factors to compare and contrast. While your first instinct may be to tap your home equity with a home equity loan or line of credit, in some cases, a personal loan could be a better choice.
To judge whether getting a personal loan for home improvements makes financial sense, you’ll want to consider the size and cost of your project and the amount of equity you have in the home. On top of that, you’ll also want to weigh your comfort level with secured vs. unsecured borrowing. Finally, consider fixed versus variable interest rates, predictable versus flexible dollar amounts, repayment terms and tax benefits.
What is a home improvement loan?
Home improvement loans are simply personal loans by another name, which you can use to fund your next renovation project. Even if you don’t see a lender offering specific home improvement loans, many will let you select home improvements as your loan purpose when you apply for a personal loan.
Like all personal loans, home improvement loans generally have fixed interest rates and a fixed repayment timeline. You’ll receive all the funds upfront and soon after you’re approved, and your monthly payment will be consistent for the duration of your loan. They’re also unsecured, making them a slightly safer alternative to home equity loans or home equity lines of credit (HELOCs), which use your home as collateral.
You should also know that some lenders offer different terms or rates for personal loans used for home improvement. For example, LightStream’s loans feature a starting APR of 3.99 percent (with AutoPay). But if you’re planning to use the loan proceeds for a home improvement project, the starting APR increases to 4.99 percent. Furthermore, the repayment term also impacts borrowing costs – the longer the term, the higher the APR.
Is using a personal loan for home improvements a good idea?
Using a personal loan for home improvement can be a great option for small or mid-sized projects, like new windows or a room makeover. Whether or not a personal loan is the right fit for your next project comes down to comparing a mix of financial pros and cons with your situation.
Before applying for a personal loan to finance your next project, it’s important to know the benefits and the potential downsides.
- You won’t risk losing your home. With a personal loan, you’re not borrowing against the value of your home. If you can’t repay your home equity loan or HELOC, your lender can eventually foreclose because your home secures these loans. While lenders offering unsecured home improvement loans can still place a lien against your home if you don’t pay them, the lien usually just makes selling or refinancing more difficult. It won’t get you kicked to the curb like a foreclosure unless the creditor gets a writ of execution from a judge to force the sale of your property, which isn’t likely.
- It’s easier to keep borrowing in check. Unlike a HELOC, which allows you to keep borrowing throughout the 10-year draw period, a personal loan amount is fixed when your loan is approved. Most also have lower minimums than HELOCs and home equity loans, often requiring you to borrow at least $10,000. This makes personal loans a good option for lower-cost home upgrades.
- You’ll get a more predictable monthly payment. The fixed interest rate on a personal loan also means your monthly payment will stay the same, making it easier to work into your spending plan each month over the life of the loan.
- You’ll pay fewer fees. Personal loans sometimes have origination fees, but they don’t have all of the closing costs that come with home equity loans and HELOCs. That includes application fees, appraisal fees, annual fees, points, title search and title insurance fees, mortgage preparation fees, filing fees and early repayment fees. When comparing the price of a home equity loan and a personal loan, it’s important to factor in these upfront costs.
- You could get your funds faster. Applying for a personal loan is generally a seamless process that can be completed online in minutes. Furthermore, many lenders offer same or next-day funding, which means you can get started on home improvements immediately.
- Creditworthiness is the biggest factor in qualifying. Home equity loans may be easier to qualify for if you have a poor credit score because you’re using your home as collateral. Personal loans, on the other hand, typically place a heavier emphasis on your credit score, debt-to-income ratio and income.
- You’ll pay higher rates. Because most personal loans are unsecured, they typically charge higher interest rates than home equity loans and HELOCs. The rate may be unaffordable if your credit isn’t in good shape.
- You won’t have any payment flexibility. Personal loans have a fixed repayment timeline and interest rates, meaning you’ll be locked into the same payment every month. If you opt for a HELOC, you’ll have slightly more flexibility since most require only interest payments during the draw period.
- You’ll get a shorter repayment period. Compared to home equity loans, which often come with loan terms of up to 30 years, personal loans give you far less time to repay what you owe. Personal loan terms are generally limited to seven years.
- You can’t deduct interest on your tax returns. One of the biggest advantages of using a home equity loan or HELOC for home improvements is that you can deduct the interest paid if you itemize and use the funds to buy, build or substantially improve your home. There are no tax benefits to using a personal loan for home improvements.
Ultimately, you want to consider the benefits and drawbacks of using a personal loan for home improvements. If you find it a good fit for your financial situation, the next step is to shop around to find lenders with competitive loan terms. Otherwise, you should explore other funding options.
How to get the best home improvement loan rates
If you’re thinking of using a personal loan for home improvement, it’s crucial to take steps to save as much money as possible. Paying attention to the lending market may help: After pulling back on lending activity during the height of the pandemic, for instance, lenders may be expanding competitive personal loan products for all borrowers in 2022, suggests TransUnion’s Financial Services 2022 Consumer Credit Forecast.
For most, personal loan interest rates range from about 3 percent to 36 percent, with an average rate of around 10.3 to 12.5 percent for those with excellent credit. Here are some ways to ensure that you get the best rate you qualify for:
- Improve your credit: If your credit isn’t where you want it to be and the home improvement project isn’t urgent, take some time to improve your credit score. To begin, check your credit score and get a copy of your credit reports to figure out which areas you can address. This may include catching up on late payments, paying credit card debt or disputing inaccurate credit report information.
- Get prequalified: Many personal loan companies allow you to get prequalified with just a soft credit check before you apply. This process will provide you with some loan offers based on your creditworthiness, so it’s a good way to compare your rates from multiple lenders. Remember that you won’t get a final offer until you officially apply, and there’s no guarantee that it will be the same as the initial offer.
- Skip the origination fee: While origination fees are common with personal lenders, they’re not ubiquitous. Look for lenders that don’t charge an origination fee as you shop around. This can save you hundreds of dollars from the get-go.
- Opt for a shorter repayment term: The longer you take to repay your loan, the higher the interest rate will be. What’s more, dragging out payments for a longer period gives the loan more time to accumulate interest. If you can afford a shorter repayment term for your personal loan, it can save you a lot of money.
Alternatives to personal loans for home improvement
If you’re on the fence about a personal loan or you know it isn’t the route you want to go for financing your renovation, here are a few other options to consider:
- Home equity loan: Like a personal loan, a home equity loan disburses one lump sum you repay in fixed monthly payments. You put up your home as collateral, driving the interest rate down. But if you default, you could lose your home. Also, closing costs are typically high.
- HELOC: A HELOC is a secured loan and a revolving line of credit, meaning you draw money as needed. Interest rates are often low but typically variable, so they fluctuate over time. As with home equity loans, the biggest downsides are that you could lose your home if you can’t pay what you owe and that closing costs can be expensive.
- Cash-out refinancing: Refinancing replaces your current mortgage with a new mortgage and a new interest rate. Using a cash-out refinance, you would take out a new mortgage for more than you owe on your house and use the difference to fund your home improvement project. But closing costs can be steep, and it may not make sense if interest rates are higher than what you’re paying on your current mortgage loan.
- Title I property improvement loan: This government loan is guaranteed by the Federal Housing Administration (FHA) and designed specifically for home improvements, renovations and repairs. Limits are typically lower than those of home equity options and personal loans, and you may need to provide collateral depending on your loan amount. But if you’re a low- to moderate-income homeowner, this may be the best approach.
- Credit cards: On the surface, it may not seem like credit cards are a good idea for funding home improvements because of their high interest rates. But if you have good credit, you may qualify for a card that offers a 0 percent introductory APR for 18 months or more.
There’s no single best way to fund a home improvement project, and the right financing option for you will be the one that fits your financial situation, preferences and priorities. Using a personal loan for home improvements may make sense if you need a smaller loan amount, want to minimize borrowing risks and prefer predictable payments.
You’ll also need to consider the higher interest rate, loss of tax benefits and other factors before settling your loan. Take some time to compare all of your options before you decide. If you determine that a personal is right for you, shop around to find a lender that offers competitive rates and fees and has a positive customer service reputation.