Home improvement loans are a type of personal loan that allows you to use your funds to finance all or part of a home improvement project. From small renovations to full room remodels, a home improvement loan can be a useful tool.

But interest rates can be high if you don’t have great credit. They might also have high fees and prepayment penalties, which will make it difficult to save money on costs.

Home improvement loan benefits

Home improvement loans are an important tool for homeowners who need to make essential or cosmetic changes to their space. Because they are fixed rate and let you borrow a large lump sum at once, they are a useful way to make projects more affordable.

Helps build credit

On-time payments will always be a great way to build up your credit score and make future borrowing less expensive. In addition, you can build your credit by expanding the types of credit accounts you have. If you only have a few installment loans, a home improvement loan can diversify your credit profile, which looks good to lenders and can boost your score.

Finance a large project

There are lenders that offer up to $100,000 in personal loan funds. Not everyone will be able to qualify for such a large amount. But if you have a big project and the income to afford large monthly payments, opting for an unsecured home improvement loan will help lower the risk of losing property if you default.

Add value to your home

A home improvement loan will add value to your home by allowing you to tackle a larger project than you could otherwise save for. By being able to afford renovations or remodels, you can add value to your home with a home improvement loan. If you plan to sell your home, you can recoup some of what you spent — and make your home stand out more on the market.

Fixed payments

Home improvement loans are fixed-rate installment loans. This means that you will have the same payment every month. And that makes budgeting significantly easier than if you had funded your project with a credit card or HELOC.

Home improvement loan drawbacks

Home improvement loans aren’t for everyone. Fees and hard credit pulls, along with other factors, can make them a bad choice in some situations.

Potentially high fees

Not every lender charges the same fees. There may be an origination fee on your loan that either deducts from the total amount you receive or increases the amount you borrow. There may also be late fees and prepayment penalties. And while both can be avoided, a prepayment penalty makes it much more difficult to save money if you are able to pay your loan off ahead of schedule.

The interest rate and unavoidable fees play into your annual percentage rate (APR). And if you have poor or fair credit, you may be faced with an APR upwards of 36 percent. While not everyone will need to be concerned with high APR, it may make a home improvement loan far too costly.

Some loans are secured

Most personal loans are unsecured, which means they don’t require collateral. However, some may be secured either by your home’s equity or by another asset, like a savings or investment account. If you are unable to pay your loan and default, the lender will seize your collateral. This results in extra risk for you — even if it comes with lower rates than an unsecured loan.

Negative impact on credit

Applying for a home improvement loan will result in a small hit to your credit when the lender does a hard pull. It may also lower your credit score if you miss any payments. But even if you make every payment on time, your credit could still be worse off. If it skews your credit utilization ratio or increases your overall debt-to-income (DTI) ratio, you may see a negative impact on your credit score that will be difficult to overcome.

When to get a home improvement loan

A home improvement loan — as opposed to a home equity loan or HELOC — is a good choice if you have a midsize project. You will need to have good to excellent credit to get the best rates, but even borrowers with fair credit may be able to take advantage of longer repayment terms to minimize monthly costs for necessary improvements.

Alternatives to a home improvement loan

Using your home’s equity, a credit card or your savings will be the most accessible alternatives to a home improvement loan.

  • Home equity loan. A home equity loan allows you to tap the equity you have in your property. These tend to have lower rates than home improvement loans because they are secured. And just like a personal loan, they have fixed monthly payments and long repayment terms.
  • HELOC. A home equity line of credit (HELOC) also uses your equity as collateral. But it functions more like a credit card — you draw from your line of credit when you need to make a purchase. When that money is repaid, you will be able to draw from it again.
  • Credit card. Credit cards are best for smaller projects, including weekend DIY. Even if you have a low credit limit, you may be able to purchase materials or pay for labor, then pay it off. But because minimum payments can cause interest to pile up, be sure you can afford to pay all or most of the amount by the end of the month.
  • Savings. The option that costs you the least will be to build up your savings. This is the best alternative to a home improvement loan because you won’t pay any interest — in fact, you may be able to earn interest if you have your money in a savings account.

Home improvement loans should be used carefully

Home improvement loans are an important tool for many people who may not be able to build up their savings. But even if you can score low rates, they may still be risky if you struggle to keep up with payments or borrow too much.