A homeowner’s first instinct may be to get a home equity loan or line of credit when they need money for a home improvement project. But in some cases, a personal loan could be a better choice.
With a personal loan, you know your total borrowing costs at the time you take out the loan, and you’re borrowing a fixed amount for a certain number of years with a fixed interest rate. 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.
Should I get a personal loan for home improvements?
A personal loan can be a great way to finance a small to mid-sized home improvement project, 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. Here are a few examples to be aware of.
- You won’t risk losing your home. If you can’t repay your home equity loan or HELOC, your lender can eventually foreclose, since these loans are secured by your home. While unsecured creditors can place a lien against your home if you don’t pay them — something many consumers are unaware of — 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 usually have origination fees, but they don’t have application fees, appraisal fees, annual fees, points, title search and title insurance fees, mortgage preparation and filing fees or early repayment fees like home equity loans and HELOCs typically do. When comparing the price of a home equity loan and a personal loan, it’s important to factor in these extra fees.
- Creditworthiness is the biggest factor in qualifying. Home equity loans may be easier to qualify for if you have a poor credit score, since you’re using your home as collateral. Personal loans, on the other hand, typically place heavy emphasis on your credit score, debt-to-income ratio and income. These factors also determine your rate — if you don’t have a good credit score, your personal loan could be expensive.
- You won’t have any payment flexibility. Personal loans have a fixed repayment timeline and fixed interest rates, which means 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 pay higher rates. Because most personal loans are unsecured, they typically charge higher interest rates than home equity loans and HELOCs, and you may face additional fees on top of that rate.
- 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.
The choice between a home equity loan and a personal loan for home improvements comes down to your priorities and needs. There’s a reason why home equity loans are so popular for home improvements — on top of low interest rates, you can also take advantage of tax benefits. However, personal loans may make more sense if you need a lower loan amount or if you prefer to minimize borrowing risks.
Alternatives to personal loans for home improvement
If a personal loan isn’t the route you want to go for financing your renovation, here are a few other options to consider:
- Home equity line of credit (HELOC): A HELOC is a secured loan and a revolving line of credit, meaning you draw money as you need it. A major downside is that you put your home up as collateral, and your interest rate is typically variable.
- Home equity loan: A home equity loan, like a personal loan, disburses one lump sum that you repay in fixed monthly payments. As with a HELOC, you put up your home as collateral.
- 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 mortgage for more than you owe on your house and can use the difference to fund your home improvement project. However, mortgage refinancing only makes sense if the new interest rate is lower than the original interest rate.
If you’re looking to make home improvements, the first thing you’ll want to do is conduct a financial audit to determine which type of financing is best for your situation. 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.