When you need money for a home improvement project, your first instinct may be to tap your home equity with a home equity loan or line of credit. But in some cases, a personal loan could be a better choice.
To determine whether or not you should get a personal loan for home improvements, consider your priorities when it comes to interest rates, secured versus unsecured borrowing 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.
Home improvement loans, like all personal loans, generally have fixed interest rates and a fixed repayment timeline. You’ll receive all of your funds upfront, 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).
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 really comes down to one thing: your financial health and history.
Before applying for a personal loan to finance your next project, it’s important to know both the benefits and the potential downsides.
- You won’t risk losing your home. If you can’t repay your home equity loan or HELOC, your lender can eventually foreclose because these loans are secured by your home. 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 will 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, both of which often require you to borrow at least $10,000. This makes personal loans a good option for lower-cost home upgrades.
- 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.
- 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. If your credit isn’t in good shape, the rate may be unaffordable.
- You won’t have any payment flexibility. Personal loans have a fixed repayment timeline and fixed interest rates, which means that you’ll be locked into the same payment every month. If you opt for a HELOC instead, you’ll have slightly more flexibility, since most require only interest payments during the draw period.
- 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 use the funds to buy, build or substantially improve your home. There are no tax benefits to using a personal loan for home improvements.
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.
For the most part, personal loan interest rates range from about 3 percent to 36 percent, with an average rate of around 11 to 12 percent. 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 getting caught up on late payments, paying down 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. Just keep in mind 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. As you shop around, look for lenders that don’t charge an origination fee. This can save you hundreds of dollars from the get-go.
- Opt for a shorter repayment term: The longer you take to pay back 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 big time.
The choice to use a personal loan for home improvements comes down to your priorities and needs. Personal loans may make more sense if you need a lower loan amount or if you prefer to minimize borrowing risks.
But you’ll also need to consider the higher interest rate, loss of tax benefits and other factors before you settle on your loan. Take some time to compare all of your options before you decide.
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: A home equity loan, like a personal loan, disburses one lump sum that you repay in fixed monthly payments. You put up your home as collateral, which drives down the interest rate. 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 you need it. Interest rates are often low but typically variable, which means that they can 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.
If you’re looking to make home improvements, the first thing you’ll want to do is conduct a financial audit. Remember, the best way to finance home improvements is the way that best fits your financial situation, preferences and goals.
For example, if fixed monthly payments are your goal, a personal loan or home equity loan are good options. But if you want to have greater control over your spending, a personal loan doesn’t make as much sense as a HELOC.
Personal loans could be a good option for some people. If this is the case for you, shop around to find a lender that offers competitive rates and fees and has a positive customer service reputation.