Home improvement projects are frequently an expensive cost that can be difficult to manage with savings alone. In fact, the average U.S. homeowner spends about $18,000 a year on home renovations.

Fortunately, you can make these expenses more affordable by financing them through a home improvement loan. These loans usually carry lower rates than credit cards, and come with fixed repayment terms and interest rates, making monthly payments more predictable. That said, there are some factors to consider before applying for one.

What is a home improvement loan?

A home improvement loan is a type of personal loan specifically designed to fund emergency home repairs, as well as home improvement or renovation projects. These may include anything from fixing a leaky roof to a full kitchen remodel.

Types of home improvement loans

There are five main options when it comes to borrowing money for home projects:

  • Personal loans: These loans are typically unsecured, meaning they use your credit score and income to determine your eligibility. Because of this, they tend to have higher interest rates than the other types of loans mentioned below. Still, you could get an interest rate as low as 4.6 percent if you have a stable source of income and excellent credit. Personal loans are a great option for those who already have a set budget for their home improvement projects, as these are taken out for a specific amount.
  • Home equity line of credit (HELOC): HELOCs use your home equity as collateral for the loan — which means you may lose your home if you land in default. Aside from this risk, they provide the same spend-on-the-go flexibility as credit cards, with a much lower interest rate. HELOCs are best suited for those with an ongoing home project that don’t have a set budget.
  • Home equity loan: Just like HELOCs, these loans also use your home equity as collateral. And like a personal loan, you borrow a lump sum and pay it back in even installments. But they tend to have lower rates because they are secured by your home. Home equity loans are an ideal solution if you have less-than-perfect credit and don’t qualify for a low rate with an unsecured loan.
  • Cash-out refinance: A cash-out refinance consists of replacing your mortgage for a new one that lets you tap into your equity. For these types of loans you’ll need to have at least 20 percent of equity in your home. These are best suited for extensive home renovations.
  • Government loans: The U.S. Department of Housing and Urban Development (HUD) offers a type of loan, known as Title I Property Improvement Loan, which can help you renovate your home for very little if you meet the eligibility requirements. These loans can also be used in conjunction with a 203(k) Rehabilitation Mortgage, which is another government loan that allows eligible homeowners to roll up to $35,000 into their mortgage for renovations or home improvements projects.

How does a home improvement loan work?

Whether you opt for an unsecured or secured home improvement loan, they essentially work the same. You get a lump sum, which is repaid over a set period of time with a fixed interest rate. These funds can be used to pay for permits, contractors, equipment, materials and labor needed to complete the work. This can be done for one big project or piecemeal if you are tackling multiple, smaller projects.

No matter how long it takes to complete the home improvement, you will begin making monthly payments immediately. The exact amount you pay will depend on how much you borrowed and your rate. When selecting a loan, ensure you have the room in your budget to comfortably make monthly payments — and cover any unexpected costs that may crop up during the renovation process.

Where to get a home improvement loan

Most home improvement loans are either going to be unsecured personal loans or a secured loan that uses your home’s equity. This means you will find options offered by online lenders as well as banks and credit unions.

  • Online lenders. There are a wide variety of online lenders — and many work with bigger banks to offer low rates. Unsecured personal loans are common, so you should be able to find a lender that works with your credit score and income.
  • Banks. These typically offer both personal loans, as well as HELOCs or home equity loans. Start with the bank you already use, then compare rates from other national and local banks. In most cases, you won’t need an account to apply. That said, banks tend to have more stringent credit requirements than online lenders and credit unions, so you’ll most likely need good-to-excellent credit to qualify for these loans.
  • Credit unions. Unlike banks, you will need to have a checking or savings account with a credit union to qualify for a home improvement loan. But unlike banks and online lenders, credit unions typically have lower rates and more flexible credit requirements.

Home improvement loan requirements

Like any loan, lenders consider your credit score, income and debts when determining if you qualify. A secured loan — like a HELOC — will also take the value of your property and the amount of equity you have into account. The most equity you have and the more your home is worth, the more likely you are to get a competitive rate.

What credit score is needed for a home improvement loan?

If you’re going for a personal loan to finance your home improvement project, you’ll likely need a credit score of at least 600 to qualify, or add a co-signer that meets this requirement. For secured loans, you’ll usually need a credit score of at least 620 to get approved.

However, to get the lowest rates, you will need good credit. In most cases, that means a score of 670 or higher. Additionally, most lenders will require a low debt-to-income (DTI) ratio, which is a measure of how much money you have left after paying all your monthly bills. The ideal DTI ratio for home improvement loans is 36 percent or under. Some lenders also have a minimum household income requirement, so make sure to check this out before applying for a loan.

How to apply for a home improvement loan

Applying for a home improvement loan is pretty much the same as applying for a personal loan. Follow the steps below to ensure you get the best deal for your situation.

  • Research loan options and lenders. Since there are both secured and unsecured home improvement loans, you will need to figure out which best suits your needs. Secured loans have lower rates on average, but they come with the risk of losing your property if you default.
  • Gather documentation. Lenders will need to see proof of employment, residence and identity. A Social Security number, bank statements, pay stubs and information about your project and property are all necessary to complete an application.
  • Submit for prequalification (if available). Prequalification allows you to preview a potential rate without affecting your credit score. If you like what you see, you can submit a full application while also checking rates from lenders that don’t offer prequalification.
  • Compare offers. Once you have applied with a few lenders, compare offers. Consider the interest rate, loan term and total cost of the loan by taking into account other factors, such as application fees, origination fees, late fees and prepayment penalties.

When not to get a home improvement loan

A home improvement loan is a good fit if you have a larger project that has multiple costs. A weekend DIY that costs less than $1,000 is better covered by savings or a low-interest credit card.

Many personal loans will have a minimum amount you can borrow. Some lenders allow as little as $1,000. Most, however, will set the minimum amount in the $2,000 to $5,000 range. This is especially true for loans that use your home equity. You should avoid borrowing more than you need, even if your loan doesn’t have a prepayment penalty.

You should also avoid a loan if your budget is already tight. Even loans with low interest rates can be costly, and you need to ensure you will be able to repay to keep your credit score intact. If you already have poor credit, find ways to improve your score before applying for a loan.

The bottom line

Home improvement loans are a key way to fund big projects. While they aren’t good for every homeowner, they can be a solid tool if you know your budget and have good credit.

Start by comparing lenders and looking into what your current bank offers. You may be able to find a good deal — just be prepared to research and provide details on how you will use your loan to upgrade your living spaces.