There are six common types of home improvement loans: cash-out refinancing , FHA 203(k) Rehab Loan, home equity loans, home equity line of credit (HELOC), personal loans, and the credit cards. Each of these comes with its own benefits and drawbacks. For example, some loans require that you use your house as collateral in the loan (more on that below), and some loans are better for smaller projects with less expenses, just for starters. Below we’ll discuss each loan type in detail and when it is wise to use that type of loan for home improvement.
1. Cash-out refinancing
Cash-out refinancing is a popular method to get money for a home renovation project.
It works like this: You refinance to a new mortgage loan with a bigger balance than what you presently owe. Then you pay off your existing mortgage and keep the remaining cash.
The money you receive from a cash-out refinance comes from your home equity. It can help you accomplish your home improvement goals; although there are no regulations that say cash-out funds must be used for home improvements. You can just as easily invest your cash, or pay off your debt.
Cash-out refinancing pros:
- You can use the money for debt consolidation
- Interest rates are lower than HELs and HELOCs
Cash-out refinancing cons:
- Closing costs may higher than
- New loan will have a larger balance than your current mortgage
- Paying off your mortgage will take longer
2. FHA 203(k) rehab loan
An FHA 203(k) rehab loan, also referred to as a renovation loan, enables homeowners to finance their mortgage and home improvement costs through a single loan.
With an FHA 203(k), you don’ t have to apply for multiple loans or pay closing costs twice. Instead, rehab loans allows you to purchase or refinance your primary home and renovate it with one convenient loan.
FHA 203(k) rehab loans are good option when you’ re buying a fixer-upper that requires multiple repairs and know you’ ll need loan funding for home improvement projects soon.
And these loans are backed by the Federal Housing Administration (FHA), which means you’ ll get special benefits – like a lower down payment and credit score, and competitive interest rates compared to other loan types.
FHA 203(k) rehab loan pros:
- Competitive interest rates compared to other loan types
- a minimum down payment of 3.5% for those who possess a credit score of 580 or above.
- You don’t need to be a first-time home buyer
FHA 203(k) rehab loan cons:
- Designed only for older and fixer-upper homes
- Renovation costs must be at least $5,000
- Can not be used for investment properties
3. Home equity loan
A home equity loan (HEL) is a useful way for you to borrow against the equity of your home when your assets are tied up in your property.
Unlike a cash-out refinancing, a home equity loans offer lower interest rates than other loans, they are often called second mortgages because you have another loan payment .
If you already have a mortgage, you’d continue making its monthly payments, while also making payments on your new home equity loan.
Home equity loan pros:
- Easier to qualify for than many other types of loans
- Interest rates are fixed and low rates
- You can borrow up to 100% of your equity
- Loan terms are longer than many other loans
Home equity loan cons:
- You’ ll have a second mortgage to pay off on top of your primary mortgage
- You’ ll have to pay closing costs, unlike other consumer loans
- Disperses one lump sum so you’ ll need to budget home improvement projects carefully
4. HELOC (home equity line of credit)
You could also finance home improvements using a home equity line of credit or “HELOC”. A HELOC is similar to a HEL, it is a line of credit secured by your home that gives you a revolving credit line to use for large expenses or to consolidate higher-interest rate debt on other loans such as credit cards.
You can borrow against the available equity in your home and the house is used as collateral for the line of credit.
Another difference between home equity loans and HELOCs is that HELOC interest rates are not fixed – they can rise and fall over the loan term.
But, interest is only charged on your outstanding HELOC balance – the amount you’ ve actually borrowed – and not on the entire line of credit.
At any time, you could borrow only a portion of your maximum loan amount, which means your payments and interest charges would be lower.
HELOC pros:
- Low or no closing costs
- Lower interest rates than with credit cards
- Interest charged only on the amount of money you use
HELOC cons:
- Loan rates are often fluctuate, meaning your rate and payment can go up
- May lose your home if you can’t pay off in time
5. Personal loan
If you don’ t have a home to borrow against, an unsecured personal loan is another way to get some money.
You don’ t need to use your home as collateral because personal loan is unsecured loan, which means these loans can be obtained much faster than HELOCs or home equity lines of credit. You can get loan funding in 1-3 business day in some situation.
Personal loans can have adjustable or fixed rates, but typically, personal loan has a higher interest rate than a home equity loan or HELOC, the interest rate depends on several factors: your income, your credit score, repayment term, loan size etc.
The loan length for a personal loan is less flexible: Often it’s two to five years. And you’ ll probably pay closing costs.
Those terms might not sound all that favorable. But personal loans are a lot more accessible than HELOCs or home equity loans for some borrowers.
Personal loans also make sense to finance emergency home repairs – if your water heater or HVAC system must be replaced immediately, for example.
Personal loan pros:
- Fast online application process
- Funds available quickly
- Good for emergency home repairs
Personal loan cons:
- Loan rates driven by creditworthiness
- Lower borrowing limits
- Shorter loan repayment terms
- Some have prepayment penalties
6. Credit cards
You could always finance some or all of your renovation costs with credit card, it is the quickest and simplest financing option for your home improvement plan. The biggest advantage is you don’t need to fill out a loan application.
But you may need higher credit limit or apply more than one credit card , because home improvements often cost thousands of dollars at least.
Plus, the interest rates charged by most credit cards are among the highest you’ll pay anywhere.
Credit card pros:
- Easy to apply
- No-interest options available
Credit card cons:
- High interest rates and fees
- Credit cards limits are often lower than home improvement budgets
The bottom line
Financing a home remodeling is a big task, homeowners should compare all the options and choose the method that is best for their project and financial situation. You can talk to multiple lenders to get the best terms.