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A MoneyTips Guide to Home Improvement Loans

TLDR

What You Need To Know

  • A home improvement loan is any loan you take out to cover the costs of home repairs, upgrades, remodels, additions and other renovations
  • You can finance home improvements with a personal loan, home equity loan, government-secured loan or credit cards
  • To get a home improvement loan, you’ll generally need a credit score of at least 620, but exact credit requirements depend on the lender

Contents

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Feel at Home Settle in with home improvement tips & tricks. 🔨
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Thinking of renovating or remodeling your home? You’re in good company. More people than ever are choosing to stay put, investing their time, money and effort into home improvements instead of selling. 

But let’s face it, home improvements can cost thousands of dollars. Some of us may not have the finances to make that dream home makeover come true. So how do you pay for it? 

To make the most of your investment in your home, it helps to have the best home improvement loan for your financial circumstances. Use this guide to get the insight and information you need on how home improvement loans work and what type of loan might be the best fit for you.

What Is a Home Improvement Loan?

A home improvement loan is any loan you take out to cover the costs of home repairs, upgrades, remodels, additions and other renovations. 

There are a wide range of financing options out there, and each loan offers something different. Options include secured loans (those that require collateral) and unsecured loans (no collateral required) as well as secured and unsecured lines of credit. You can finance home improvements with a personal loan, home equity loan, government-secured loan or credit cards.

How Do Home Improvement Loans Work?

Here are some of the most common types of home improvement loans, how they work as well as pros and cons for each.

Personal loan

A personal loan is typically an unsecured installment loan, though some lenders may also offer a secured personal loan with a lower interest rate. 

With a personal loan, you’ll get your loan funds as a lump sum, usually $2,000 – $50,000. You pay it back, plus interest, in monthly payments with a fixed rate over a set repayment term, typically 1 – 7 years. 

PROS of a Personal Loan👍

No collateral

An unsecured personal loan doesn’t require collateral. So there’s no risk of losing your property if you default.

Quick funding

You can get your funds quickly, usually within a week, and sometimes within 1 business day.

CONS of a Personal Loan👎

Fees

Some lenders charge fees, like origination fees or prepayment penalties.

Higher interest rates

Unsecured loans have higher interest rates than secured loans, especially if you have bad credit. For unsecured personal loans, the average rate is somewhere in the range of 8.8% – 9.9%[1]

Cash-out refinance

A cash-out refinance (or cash-out refi) replaces your current mortgage with a new one for more money than you owe. You get the extra money as a lump sum to use for whatever you’d like. 

In general, you’ll need at least 30% equity in your home to qualify for a cash-out refi. 

PROS of a Cash-out Refinance👍

One payment

Because you’re replacing your existing mortgage, you’ll have one monthly payment.

Big cash payout

Most lenders will let you borrow up to 80% – 90% of your home equity.

CONS of a Cash-out Refinance👎

May need mortgage insurance

You may be able to get a cash-out refi with less home equity, but you’ll probably need private mortgage insurance (PMI).

Closing costs

A cash-out refi is a new mortgage, so you’ll likely pay closing costs, which average 3% – 6% of the loan amount.

Home equity loan

A home equity loan is a type of second mortgage that lets you tap the equity you’ve built up in your home. It uses your home as the loan’s collateral, so it’s a secured loan. 

With a home equity loan, you get your loan funds as a lump sum of up to 85% of your home’s equity. The borrower repays the loan, plus interest, in fixed installments over a set repayment term, usually 5 – 15 years.

PROS of a Home Equity Loan👍

Lower interest rate

Because a home equity loan is secured, the interest rate will be lower than for an unsecured loan. On average, home equity loan rates for a 5-year term tend to be 4.5% – 5.0%.[1]

Predictable payments

Home equity loans have fixed interest rates, and you borrow a lump sum of money. So your monthly payments are predictable.

CONS of a Home Equity Loan👎

Equity requirements

You’ll typically need at least 20% equity in your home to qualify for a home equity loan.

Two payments

Because you’re taking out an additional mortgage, you’ll have two monthly payments.

Home equity line of credit (HELOC)

Think of a HELOC as a sibling to a home equity loan. They’re both second mortgages that leverage your home’s equity. However, there are key differences between a HELOC and a home equity loan.

A HELOC typically has a variable interest rate, meaning it can fluctuate after an introductory period and any time the market rate changes. Instead of getting a lump sum, you get an amount of money you can borrow from, as you need, and only pay interest on what you borrow. 

A HELOC has two periods. The first is a draw phase where you’re free to borrow against the line of credit, typically 10 – 15 years. When the draw period ends, a repayment period of up to about 20 years begins. This is when you pay back the loan.

PROS of a HELOC👍

Lower interest rate

Like a home equity loan, a HELOC is a secured loan. So you’ll have a lower interest rate than for unsecured loans, like personal loans or credit cards. Average HELOC rates are around 4.2% – 4.4%.[1]

Pay interest only on what you borrow

Because you can borrow a portion of the line of credit you get, you’ll only pay interest on what you actually use.

CONS of a HELOC👎

Equity requirements

Like a home equity loan, you’ll usually need at least 20% home equity to be approved for a HELOC.

Variable interest rate

Because the interest rate is variable, there’s a chance it could rise with market rates.

Credit card

Credit cards use revolving credit and have variable interest rates. They’re readily available to most of us, but interest rates tend to be high. Also, missing payments can rack up fees, increase your balance and negatively affect credit.

PROS of a Credit Card👍

Easy

It’s easy to use a credit card to pay for home improvement purchases, just as you would for any purchase.

Possibility of no interest or low interest

Sometimes, credit card companies offer an introductory rate at a very low, or even 0%, APR. If you can pay off what you borrow during this introductory period, it’s like borrowing money for free.

CONS of a credit card👎

Low credit limits

Depending on your home improvement project, your credit card may not have a limit high enough to fund it.

Variable interest rate

Even if you get a card with a low introductory rate, it can spike after the introductory period to 18% or higher.

Government-backed loan

The Federal Housing Administration (FHA) and United States Department of Agriculture (USDA) back loans earmarked for home improvement. They are available through approved banks, credit unions and online lenders.

The federal government also backs renovation mortgages to fund a fixer-upper home purchase.

FHA 203(k) refinance loan

There are two kinds of FHA 203(k) loans. The limited FHA 203(k) loan is for projects up to $35,000, while the standard FHA 203(k) loan is for projects that cost over $35,000. Both require you to borrow at least $5,000.

FHA title I property improvement loan

The FHA title 1 loan lets you borrow up to $7,500 in unsecured funds for a one-family primary residence. 

FHA energy-efficient mortgage (EEM)

This is a loan specifically for energy efficiency improvements for homeowners with an FHA home mortgage.

USDA section 504 home repair

This loan is for repairs, improvements, upgrades or safety and health-related renovations in rural homes. The maximum loan is $20,000 for most areas and offers a 20-year term and 1% interest rate. Applicants must make no more than 50% of the area’s median income and live in an eligible rural area.

PROS of a Government-Backed Loan👍

No equity requirements

Government-backed home renovation loans typically don’t require a minimum home equity amount.

Low credit eligibility

You may be able to qualify for a government-backed home improvement loan even if you have a low credit score.

CONS of a Government-Backed Loan👎

Might be difficult to find a lender

Lenders need to be approved by the FHA or USDA, so it can be harder to find one.

Lengthy approval process

Government-backed loans can take several weeks or months to get approved, which can delay the timeline of your project.

What Will I Need To Apply for a Home Improvement Loan?

Depending on the lender, qualifications for a home improvement loan will vary. But here’s what you should gather, and what you’ll typically need to qualify for a home improvement loan. 

  1. Get a free credit report: Creditworthiness counts. Take this opportunity to get a free credit report online. You’ll be able to check your credit history – everything you’ve applied for, borrowed, paid back and may have defaulted on.
  2. Find out your credit score: To get a home improvement loan, you’ll generally need a credit score of at least 620, but exact credit requirements depend on the lender. You may be able to get a government-backed home improvement loan with a credit score as low as 500. It’s smart to check your score and get an idea of which loan you might qualify for. As suspected, excellent credit will likely get you lower interest rates.
  3. Calculate your debt-to-income (DTI) ratio: This calculation compares how much you owe to how much you make. Let our DTI calculator do the math for you. A general guideline is to keep your DTI below 36% to qualify for new credit, though some lenders (and government-backed loans) have looser standards. But the lower your DTI is, the greater your chances of qualifying and getting better loan terms are. 
  4. Collect all income, financial account and personal information paperwork: Grab your latest pay stubs and a W-2 or two. You’ll also want your social security number, two forms of identification, tax returns and bank statements. 
  5. Select a loan option from the lender: Look for the options that match your desired interest rate and the loan amount you need to pay for your home improvement project.
  6. Fill out loan applications with lenders of interest: Once you’ve picked your favorite lenders, there’s only one thing left to do: apply! The application process is different for each lender. Some lenders will let you apply online or over the phone. Others will want you to come to a branch in person.
  7. Get ready to renovate!

Put Down the Saw: Pick The Right Loan For the Job 

Getting the home upgrades you want requires some lender comparison shopping as well as deciding which home improvement loan best suits your decor dreams and budget. 

Take your time. Research all of your options. Get the right loan and the lowest rate. And maybe pick that saw back up – or get a contractor to do the work for you!

Ready to make a change?

Whether you want to buy a house, refinance or take cash out, you’re not alone. The experts are just a click away.

  1. National Credit Union Administration. “Credit Union and Bank Rates 2022 Q2.” Retrieved July 2022 from https://www.ncua.gov/analysis/cuso-economic-data/credit-union-bank-rates/credit-union-and-bank-rates-2022-q2

ICYMI

In Case You Missed It

  1. The pros and cons of home improvement loans will vary with the type of loan you choose. Each type of loan is different, and each is more suitable for different circumstances

  2. With a home equity loan, HELOC or cash-out refinance, you use your home as collateral for the loan

  3. The lower your DTI is, the greater your chances of qualifying for a home improvement loan and getting better loan terms are

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