Compare the best home improvement loans for 2022
Home renovations cost a lot. But the good news is, you don’t have to produce the cash out of pocket.
Home improvement loans let you finance the cost of upgrades.
For example, specialized home improvement loans like the FHA 203(k) mortgage exist specifically to finance home improvement projects.
And there are standard loans — like a cash-out refinance or home equity loan — that give you cash which can be used for home remodeling or anything else.
So, which home improvement loan is right for you?
In this article (Skip to…)
- Cash-out refinance
- FHA 203(k) rehab loan
- Home equity loan
- Home equity line of credit
- Personal loan
- Credit card
- Your best option?
- Impact on credit history
- Non-home expenses
1. Cash-out refinance
One popular way to get money for a home remodeling project is with a cash-out refinance.
It works like this: You refinance to a new mortgage loan with a bigger balance than what you currently 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 be used to fund home improvements; although there are no rules that say cash-out funds must be used for this loan purpose. You can just as easily invest your cash, or put the lump sum into your bank account.
When a cash-out refinance is a good idea
A cash-out refinance is often best for homeowners who can reset their loans at a lower interest rate than their current mortgage.
You may also be able to adjust the term length to pay off your home sooner.
For example, let’s say you had 20 years left on your 30-year loan. Your cash-out refi could be a 15-year loan, which means you’d be scheduled to pay off your home five years earlier.
So, how do you know if you should use a cash-out refinance? You should compare costs over the life of the loan, including closing costs.
That means looking at the total cost of the new loan versus the cost of keeping your current loan for its life.
Keep in mind that cash-out refinances have higher closing costs, and they apply to the entire loan amount, not just the cash-out.
So you’ll likely need to find an interest rate that’s significantly lower than your current one to make this strategy worth it.
Cash-out refinance for home improvement: Pros and cons
Cash-out refinance pros:
- Cash-out comes from home equity
- You’d continue paying one mortgage payment
- You can lower your interest rate or loan term at the same time
- You can spend the cash on anything
Cash-out refinance cons:
- Closing costs apply to a large loan amount
- New loan will have a larger balance than your current mortgage
- Refinancing starts your loan term length over
2. FHA 203(k) rehab loan
An FHA 203(k) rehab loan also bundles your mortgage and home improvement costs into one loan.
But with an FHA 203(k), you don’t have to apply for two separate loans or pay closing costs twice. Instead, you finance your home purchase and home improvements at the same time, when you buy the house.
FHA 203(k) rehab loans are great when you’re buying a fixer-upper and know you’ll need loan funding for home improvement projects soon.
And these loans are backed by the government, which means you’ll get special benefits — like a low down payment, and the ability to apply with a less-than-perfect credit profile.
FHA 203(k) home improvement loans: Pros and Cons
FHA 203(k) rehab loan pros:
- FHA mortgage rates are currently low
- Your down payment can be as low as 3.5%
- Most lenders only require a 620 credit score (some may go slightly lower)
- 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
- FHA loans include upfront and monthly mortgage insurance
- Renovation costs must be at least $5,000
- 203k rules limit use of cash to specific home improvement projects
3. Home equity loan
A home equity loan (HEL) allows you to borrow against the equity you’ve built up in your home. Your equity is calculated by assessing your home’s value and subtracting the outstanding balance due on your existing mortgage loan.
Unlike a cash-out refinance, a home equity loan does not pay off your existing mortgage.
If you already have a mortgage, you’d continue making its monthly payments, while also making payments on your new home equity loan.
When a home equity loan is a good idea
A home equity loan may be the best way to finance your home remodeling projects if:
- You have plenty of home equity built up
- You need funds for a big, one-time project
A home equity loan “is dispersed as a single payment upfront. It’s similar to a second mortgage,” says Bruce Ailion, Realtor and real estate attorney.
With a home equity loan, your home is used as collateral. That means similar to a mortgage, lenders can offer lower rates because the loan is secured against the property.
The low, fixed interest rate makes a home equity loan a good option if you need to borrow a large sum. And you’ll likely pay closing costs on this loan. So the amount you’re borrowing needs to make the added cost worth it.
Home equity loan for home improvements: Pros and cons
Home equity loan pros:
- Home equity loan interest rates are usually fixed
- Loan terms can last from five to 30 years
- You can borrow up to 100% of your equity
- Great for big projects like home remodels
Home equity loan cons:
- Adds a second monthly mortgage payment for homeowners that still owe money on their original loans
- Most banks, lenders, or credit unions charge origination fees and other closing costs
- 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, but it works more like a credit card.
You can borrow from it up to a preapproved limit, pay it back, and borrow from it again.
Another difference between home equity loans and HELOCs is that HELOC interest rates are adjustable — they can rise and fall over the loan term.
But, interest is only due 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.
When a HELOC is a good idea
Because of these differences, a HELOC might be a better option than a home equity loan if you have a few less expensive or longer-term remodeling projects to finance on an ongoing basis.
Other things to note about home equity lines of credit include:
- Your credit score, income, and home’s value will determine your maximum loan amount
- HELOCs come with a set loan term, usually between 5 and 20 years
- Your interest rate and loan terms can vary over that time period
- Closing costs are minimal to none
And, by the end of the term, “The loan must be paid in full. Or the HELOC can convert to an amortizing loan,” says Ailion.
“Note that the lender can be permitted to change the terms over the loan’s life. This can reduce the amount you’re able to borrow if, for instance, your credit goes down.”
Still, “HELOCs offer flexibility. You don’t have to pull money out until you need it. And the credit line is available for up to 10 years,” Leever says.
HELOC for home improvement: Pros and cons
- Minimal or no closing costs
- Payment varies by amount borrowed
- Revolving balance means you can re-use the funds after repaying
- Loan rates are often adjustable, meaning your rate and payment can go up
- Bank or credit union can change repayment terms
- Rates are typically higher than for home equity loans
5. Personal loan
If you don’t have tons of equity to borrow from, an unsecured personal loan is another way to finance home improvements.
Because a personal loan is unsecured, you won’t use your home as collateral. That means these loans can be obtained much faster than HELOCs or home equity lines of credit. In some cases, you may be able to get loan funding on the next business day or even same-day funding.…Read More