Are home improvement loans a good idea?

When you’ve found your forever home — or even your first home — you want to make it your own. That may mean making expensive home improvements, from remodeling rooms to adding an entire wing onto the house.

Of course, not all home improvements cost the same, but any significant home project will cost a chunk of change. Many homeowners find themselves wondering how they’re going to pay for such a project, especially in times of inflation or economic uncertainty.

In fact, a recent study found that more than half of American homeowners elected to delay home improvement projects in 2023 to 2024.

Although home improvement projects carry a significant cost, homeowners have options beyond paying out-of-pocket cash.

Average cost of a home improvement

In 2021, the average American homeowner spent $18,000 on home renovations, which represents a 20% increase over the previous year. Averages can be tricky when it comes to homes, as not all homes are the same size, not everyone does the same projects, and timing and location have a significant impact on the cost of home improvement projects. 

But to help you get a general idea of what home improvements cost, the two most popular projects are bathroom and kitchen remodels, which cost an average of $11,398 and $26,240, respectively.

How do you finance home improvement projects?

The cheapest way to pay for a home improvement project is with cash, as you won’t pay any fees or interest. But it’s not always practical, given the upfront cost. So, let’s explore some of the most popular financing options for home improvement projects.

Home equity loan

Home equity loans are loans paid out in a lump sum that you can repay over a number of years in fixed monthly payments. They’re sometimes referred to as second mortgages since they are secured by putting your home up as collateral.

These loans have higher borrowing limits and longer repayment periods than standard home improvement loans. Once you’ve locked in a fixed interest rate on the loan, you don’t have to worry about market fluctuations — you’ll make the same monthly payment over the life of the loan.

Home equity line of credit (HELOC)

A home equity line of credit — known colloquially as a HELOC — is a way to borrow from your home equity without refinancing. It’s like a home equity loan, but it functions more like a credit card. The lender gives you a preapproved limit which you can borrow from, payback, and borrow from again so long as you stay under the limit.

HELOCs are secured loans backed by your home, allowing you to qualify for lower interest rates than  an unsecured home improvement loan. However, most HELOCs have variable interest rates, which means your payments may increase or decrease month to month based on market conditions. 

To get a HELOC, you must have at least 15-20% equity in your home. The amount you can borrow depends on your loan-to-value ratio (LTV), and will increase the amount you pay towards your house each month.

Home improvement loans

Banks, credit unions, and many online lenders offer unsecured personal loans known as home improvement loans. You won’t need to put your house up as collateral to qualify, and your interest rate and qualifications are mostly based on your credit score.

When you close a home improvement loan, you can get the funding in your bank account as soon as 24 hours. But while the money arrives quickly, home renovation loans usually have shorter repayment timelines (usually 2-5 years) and lower loan amounts (about $100,000 max compared to $750,000 for home equity loans).

Personal loans tend to have higher interest rates, especially for borrowers with bad credit. You may also be subject to fees for processing, late payments, or prepayments, although you won’t be at risk of losing your home if you fail to pay back the loan.

What are the best home improvement loans?

We covered three types of home improvement loans above, and each is best for different scenarios.

Home equity loan pros and cons

Home equity loans allow you to borrow against the equity you’ve built in your home. You can calculate that number by assessing your home’s value either by your purchase price or an appraisal and subtracting your mortgage’s unpaid balance.

These loans don’t pay off your existing mortgage like a cash-out refinance would. If you already have a mortgage, you still have to make monthly payments on the mortgage as well as on your home equity loan. As such, these loans are best for when you have a lot of home equity built up, and you’re using the funds for a major, one-time project.

Pros of a home equity loan:

• Interest rates are usually fixed.
• Loan terms range between five to 30 years.
• You can borrow up to 100% of your equity.

Cons of a home equity loan:

• You have to make a second monthly loan payment on top of your mortgage.
• You’ll likely have to pay between 2-5% in origination fees and other closing costs.
• Disperses as one lump sum, so you must budget carefully for long or multi-tiered projects.

HELOC pros and cons

As mentioned before, HELOCs offer more flexibility than home equity loans because they function more like a credit card, while still allowing you to tap into your home equity without refinancing. Interest rates may rise and fall over the loan term, but you’ll only pay interest on the amount you’ve actually borrowed, not the entire line of credit.

HELOCs are good options for when you have a few, less expensive or longer-term remodeling projects to finance over an extended period.

Pros of a HELOC:

• Minimal or no closing costs.
• The less you borrow, the less you’ll have to repay, and the more equity you’ll keep.
• Revolving balance allows you to borrow, repay, and borrow again against the full line of credit.

Cons of a HELOC:

• Adjustable rates mean your rate and payments may go up depending on the market.
• Banks may change repayment terms over the life of the loan.
• Rates are usually higher than home equity loans.

Home improvement loan pros and cons

When you’re lacking in home equity, home improvement loans offer an avenue for tackling home projects. Since they’re unsecured, you can obtain these loans faster than HELOCs or home equity loans; potentially even on the same day you apply.

Home improvement loans are personal loans, so terms, rates, and fees may vary dramatically between lenders. Generally speaking, however, if you have good credit, you can probably get an affordable rate. You’ll still have to pay closing costs and repay the loan in a shorter time period than other financing options.

These loans are best for new homeowners who may want to remodel a bathroom or kitchen but don’t have the home equity to borrow against. They’re also useful for emergency repairs, like a water heater or HVAC system going on the fritz.

Pros of a home improvement loan:

• Fast application and processing, with funds sometimes available on the same business day.
• No lien on your home, ensuring that you won’t lose it if you fail to repay the loan.
• You don’t need significant home equity to get one.

Cons of a home improvement loan:

• Higher interest rates than mortgages, let alone home equity loans.
• Short loan repayment terms and potential prepayment penalties.
• Many fees, from origination to late payment fees.

Alternative home improvement financing options

If you don’t want to take on a loan to finance a home improvement project, you still have other options to pay for it. Here are a few of the most common.

Personal funds or credit cards

The safest, lowest-cost way to pay for your home renovation is to simply save up enough money to pay for it in cash. Yes, you may have to wait longer to start your project since you’ll have to save up a large sum, but you won’t have to pay back a loan with interest or face financing fees.

Many homeowners also elect to put projects on credit cards to pay off the money spent over a few months. Credit card interest rates are higher than loan rates, but they’re definitely easier to use and pay off than going through the process of loan approval, setting up a payment plan, and paying back a loan with interest.

Figure out the scope and price of your project. If there are a number of small, inexpensive projects you can get done first, it makes sense to use personal funds or credit cards to get these done so you don’t accidentally take out a larger loan than you need.

Cash-out refinance

Another common way homeowners finance home improvement projects is with a cash-out refinance. In this process, the refinance replaces your current mortgage with a new, larger loan with a new interest rate. With the new loan, you pay off your remaining mortgage balance and keep the remaining cash, which can be useful in home improvements. 

That money you receive from a cash-out refinance comes out of your home equity, so this is a good option for homeowners with significant equity but less financial flexibility to afford an additional monthly loan payment. You can use a cash-out refinance to fund any kind of project, but the amount you get depends on your current mortgage, and it may carry a higher interest rate and closing costs. As such, they’re often used for smaller projects and emergency repairs. 

In any refinance, you’ll have to pay for an appraisal, origination fees, taxes, and other closing-related costs. You’ll also extend the life of your loan unless you refinance your mortgage for a shorter term. The major benefit is if you can secure a lower interest rate and if you have enough equity (or your house has significantly increased in value) to pocket a meaningful amount of cash.

Cash-out refinances can also be useful for consolidating and paying off credit card debt, handling education or emergency expenses, or financing the purchase of a second home or investment property.

If you’re planning a home improvement project, there are a number of financing options available to you. But what’s right for one person may not be right for your project. This guide will help you figure out what the best financing option is for your particular situation and goals.