• Home improvement loans allow homeowners to borrow funds to repair, remodel, or renovate their homes. 
  • Several home improvement loan types are available, including personal loans, home equity loans, home equity lines of credit (HELOCs), and cash-out-mortgage refinancing.
  • Before applying for a home loan, consider important factors such as your ability to repay the loan, the interest rate, and any fees.  

Are you looking to repair, upgrade, or customize your home? Home improvement projects allow homeowners to create spaces that suit their lifestyle. These projects may even add to the value of your property. 

With multiple home improvement loan types to choose from, finding the right funding solution to finance the labor and materials is important. 

Here is a look at how home improvement loans work, the types of loans available, and factors you should consider before applying for a home improvement loan.  

How Do Home Improvement Loans Work?

Home improvement loans are financing options for renovating, repairing, or upgrading your property. 

Home improvement funds can be used for a wide range of purposes, including:

  • Minor interior remodeling  
  • Major renovations
  • Updating fixtures
  • Roof repairs
  • Replacing old appliances with newer, more energy-efficient appliances
  • An exterior makeover
  • Home additions
  • Landscaping
  • Pool installation
  • Solar paneling
  • Adding a garage
  • Building an accessory dwelling unit (ADU)
  • Repaving the driveway

The home improvement loan lender provides funding, which the borrower repays with interest over time. These loans come in various forms, and understanding how they work can help you choose the right option for your needs.

Types of Home Improvement Loans

There are five primary types of home improvement loans. 

  Personal Loans for Home Improvement Home Equity Loans Home Equity Lines of Credit (HELOCs) Cash-Out Refinancing FHA 203(k) Loans
Collateral Required None Home Home Home Home
Payout Type Lump Sum Lump Sum
 Revolving Line of Credit
 Lump Sum Lump Sum (Purchase + Renovation)
Repayment Terms Usually Shorter-Term Usually Longer-Term Draw Period Plus Repayment Period New Mortgage Terms Mortgage Term of 15 or 30 Years
Well-Suited For Small to Medium Renovations Larger Renovations with a Set Budget Ongoing Renovations, Flexibility Refinancing and Large Renovations Buying and Renovating Fixer-Uppers

1. Personal Loans for Home Improvement

Personal loans can be used for many purposes (including debt consolidation, funding your dream vacation, or medical expenses), but a common purpose is to fund home improvements.  

Personal loans are unsecured, meaning they do not require the borrower to use any asset as collateral. Because there is no collateral, personal loans may have higher interest rates and shorter repayment periods.[1]

2. Home Equity Loans

Home equity loans allow homeowners to convert a portion of their home equity into a lump sum payout, which they can use for home improvement projects. Home equity is the value of your home minus the amount of debt owed on the home. 

Home equity loans are secured, using the home as collateral. This means the lender has the legal right to foreclose on the home if the borrower fails to repay the loan.[2] The use of collateral makes the loan less risky for the lender, which typically allows them to offer longer repayment terms and lower interest rates on secured loans like home equity loans. 

3. Home Equity Lines of Credit (HELOCs)

Like home equity loans, home equity lines of credit (HELOCs) convert a portion of home equity into cash and are secured using the property as collateral. 

Unlike home equity loans, HELOCs do not provide a lump sum payout. Instead, they serve as a revolving credit line, which homeowners can borrow against as needed (similar to the way a credit card works).[3]

HELOCs work in two phases: the draw period and the repayment period. During the draw period, homeowners can borrow against the credit limit as needed. Depending on the terms of the specific HELOC, the borrower may make interest-only payments during this period, keeping payments low until they begin repaying the principal balance during the following repayment period.[3]

Some HELOCs also offer the borrower a fixed rate lock feature which allows them to transfer their current HELOC balance into a fixed rate, repayment term, and payment.

4. Cash-Out Refinancing

Cash-out refinancing replaces an existing mortgage with a new mortgage of a larger amount, allowing the borrower to pocket the difference (after any fees or closing costs). The amount pocketed can then be used to fund home improvement projects. 

When refinancing, all terms from the original mortgage are replaced, including the interest rate and repayment schedule. This makes cash-out refinancing an attractive option for homeowners who can secure a lower interest rate by refinancing.[4] If rates have come down since the origination of the current mortgage, for example, or if the homeowner’s credit score has improved enough to qualify for a lower interest rate, the homeowner can potentially reduce their total interest expense with a cash-out refi. 

Like the existing mortgage, the cash-out refi would be secured, using the home as collateral. 

5. FHA 203(k) Loans

FHA 203(k) loans are government-backed mortgages specifically for homebuyers looking to finance both the purchase (or refinance) and renovation of a property in a single loan.[5] 

Administered by the Federal Housing Administration (FHA), these secured loans are particularly useful for properties needing significant repairs or upgrades. Borrowers can combine the home’s purchase price and the projected costs of renovations into one mortgage, streamlining the process and avoiding the need for separate financing. For well-qualified buyers, this loan typically requires a down payment of just 3.5% of the total cost (purchase price plus renovations).[5]

Because the loan is backed by the FHA, there may be more regulation regarding how the funds are to be used. 

Factors To Consider Before Taking Out a Home Improvement Loan

Before applying for a home improvement loan, consider the following. 

Eligibility Requirements

Borrower eligibility criteria vary by loan type and lender. Lenders typically assess your financial situation, which can include the following:

  • Credit scores. There is typically a minimum credit score requirement. For example, some lenders require a score of at least 600 for secured loans. Higher scores typically warrant better interest rates.
  • Debt-to-income (DTI) ratio. Your DTI is the dollar value of your monthly debt payments expressed as a percentage of your income. A lower DTI ratio is generally preferable.
  • Home equity (for secured loans). Lenders require homeowners to retain a certain amount of home equity. They may, for example, loan up to 80% of the home’s value in a cash-out refi, requiring the homeowner to retain at least 20% equity. 
  • Project scope. Some lenders may want details of your renovation plans.

Loan Costs and Interest Rates

Each home improvement loan type comes with costs. The cost varies by loan type, property location, and loan amount. 

Additionally, interest rates for each home improvement loan type can vary. In some cases, interest on amounts borrowed to fund home improvement projects may be tax deductible. You may wish to consult with a qualified tax accountant before deciding on a home improvement loan type.

It’s important to discuss the costs and interest rates for each loan type with a qualified mortgage loan officer (MLO). 

Your Financial Situation

Are you comfortable taking on debt to finance home improvements? Home improvement loans are best reserved for homeowners confident in their ability to repay the loan as scheduled. 

Alternatives To Home Improvement Loans

If a home improvement loan does not seem like the right fit for you, consider alternative funding options.

Savings

If you have savings that can be easily converted to cash, these funds can be used for the home improvement project. Doing so would save money on closing costs and interest expenses. 

However, depleting savings could leave you without a safety net in the event of a large unexpected expense or decrease in pay. 

While it is possible to borrow from retirement funds to cover home improvement projects, this is generally unadvisable due to the complexity of retirement accounts, the potential penalties for early withdrawal, and the lost future gains from lowering the capital in the account.[6]  

Credit Cards

Credit cards may be used for smaller home improvement projects or updates that you intend to pay off relatively quickly. It is important to understand the limits and financial constraints of this option.

First, the credit limit may not cover the cost of the project. Even if it does, maxing out credit cards can temporarily lower your credit score.[7]

Secondly, credit cards often carry higher interest rates than other options. However, if you can get a credit card with a 0% introductory annual percentage rate (APR) and repay the loan in full before the introductory period expires, this can be a cost-effective method for financing smaller home improvements. 

The Bottom Line

Home improvement projects can improve the functionality and increase the enjoyment of your home. Certain projects can even make your home more valuable. 

There are several home improvement loan options available to help homeowners access funds needed to tackle these projects. As you weigh your options, carefully consider the eligibility requirements, loan costs, interest rates, and your ability to repay the loan.

By understanding the options, you can make the best choice for your home.

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