Money Management

Building Equity: A Guide to Home Improvement Loan Options

Has the spring cleaning bug hit you yet? If so, while you’re straightening up your home, you may discover that you need more space or that  you’d love to tackle some larger projects like bathroom or kitchen remodels. In addition to the welcome aesthetic and functional change that renovations provide homeowners, they can also increase the value of your house significantly. But like so many other things in life, you need to spend money to make money and home improvement is no exception.

Renovations and other home projects can get expensive very quickly and few among us have the cash on hand necessary to cover all the costs. Additionally, while simply charging supplies and labor costs to a credit card may seem like the most convenient solution, this often results in paying a hefty premium thanks to the high-interest rates that most cards carry. Instead you’ll likely want to look into one of three options: a home equity loan, a home equity line of credit, or a personal home improvement loan.

Home Equity Loans and Lines of Credit

While “home improvement loans” and “home equity loans” have similar names they are far from synonymous. A home equity loan (sometimes shortened to HEL or referred to as a “second mortgage”) is a type of home improvement loan that draws from the equity of your home.

What is Home Equity?

It usually refers to the value of your home compared to what you owe on it. For example, if you’re home is appraising at $300,000 and you owe $100,000 on your mortgage, your home equity would be $200,000. In that case you could likely get a loan from your bank that borrowed against this amount. Most banks will let you borrow about 80% of your equity in the form of a loan.

Pros and Cons of HELs

One of the major advantages of home equity loans is that they can usually be secured at low-interest rates. Since the loan is tied to your home there is less risk for the lender. This also means you can typically borrow larger amounts assuming you have a lot of equity in your home.

Unfortunately, some of the things that are good about HELs also makes them unappealing to some homeowners. For one, since your home is tied into the loan, you could lose your house if you are unable to make your loan payments. HELs may also not be right for you if you want to borrow a smaller amount as some banks have a minimum withdrawal amount of $20,000 or more for home equity loans. Additionally, keep in mind that just like with your first mortgage, second mortgages require closing costs, which could be up to 6% of your loan amount.

Home Equity Lines of Credit vs. Home Equity Loans

Home equity lines of credit (HELOCs) are in the same vein as home equity loans as both are tied to the value of your home. However HELOCs allow you to take out smaller loans when you need them instead of getting one lump sum. This can often be helpful for those who haven’t nailed down an exact price for their project yet and want to play things by ear.

Another major difference between HELOCs and HELs is that, unlike home equity loans that typically have fixed-rate APRs, home equity lines of credit have variable APRs. This adds a lot of uncertainty as your payments could suddenly jump without notice. Especially considering that defaulting on HELOCs could cause you to lose your home, this aspect may scare some homeowners away.

Qualifying for HELs or HELOCs

The biggest thing to know about home equity loans and lines of credit is that not every homeowner will qualify for one. If you haven’t owned your home for very long or you owe more than your house is worth due to shifts in the market, then you won’t have enough equity to borrow from. In those cases you may want to look into a personal loan instead.

Personal Home Improvement Loans

If you don’t have equity in your home or just don’t want to tie your loan to your house, then getting a personal loan to cover your home improvements can be a great option. Whether they are advertised as home improvement loans or not, the vast majority of personal loans can be used for home projects and remodels. Most personal loans are unsecured meaning that you will not have to put up collateral (like your house) in order to get them.

Pros and Cons of Personal Loans

Overall using a personal loan to complete home improvement projects gives homeowners more freedom than with HELs or HELOCs. The amount of money you borrow and the length of the loan can vary, allowing you to set terms that make sense for you and your financial situation. When shopping for loans you’ll also want to get one that’s fixed rate and has no prepayment penalty.

One thing that may be an issue for some borrowers when it comes to personal loans is their credit. Unlike with home equity loans, personal home improvement lenders will base their decision and your interest rate off of your credit score and other indicators of credit worthiness. If you have good credit then this is not a problem. However those with less than stellar credit may end up paying significantly higher rates than they would with HELs. Additionally, while you won’t lose your home if you default on a personal loan, doing so will have lasting and damaging effects on your credit.

Where to Get a Personal Home Improvement Loan

There are several options for personal loans and many more are popping up all the time. One traditional route is to visit your local bank or credit union and see what offers they have for you. Alternatively many online lenders are now offering homeowners personal loans that are quick and easy to obtain.

Lending Club is just one of these online lenders that now offer home improvement loans. Homeowners can borrow as little as $1,000 and as much as $40,000 on Lending Club’s marketplace lending platform. These personal home improvement loans have fixed-rate APRs, have no pre-payment penalties, and are typically funded in just days. This will enable you to get to your project even faster.

The Bottom Line

Spring is in the air and now is a great time to add equity and value to your home by doing an expansion or remodel. However, this often requires homeowners to take out a loan in order to fund the materials, equipment, and labor they’ll need to make these projects a reality. Home equity loans, home equity lines of credit, and personal home improvement loans all have their advantages but there are also potential downsides to consider as well. Ultimately only the homeowner can say which loan type is best for them and their family.