Whether a major renovation or a remodel, starting a home project can be a huge undertaking. But finding the right financing option can help make the process run more smoothly and hopefully minimize the financial burden.
Homeowners today have a number of financing options available, but two popular options are home equity loans and home improvement loans. These loan types carry very different terms, requirements, loan amounts and more — details that can help you decide which is best suited for your project. Below, well break down everything to know about each one before you apply.
Financing home improvements can be tricky. There are several options to choose from, each with their own pros and cons. Two popular choices are home improvement loans and home equity lines of credit (HELOCs). But how do you know which one is right for your situation?
In this comprehensive guide, we’ll explain everything you need to know about home improvement loans and HELOCs. We’ll compare interest rates, fees, loan amounts, qualifications, and more. By the end, you’ll understand the key differences and be able to decide which financing option makes the most sense for your next home project.
Overview of Home Improvement Loans
A home improvement loan is an unsecured personal loan that you can use to finance upgrades, renovations, or repairs to your home. The loan amount usually ranges from $1,000 to $100,000, with repayment terms of 1 to 7 years typically.
With an unsecured loan, you don’t put up any collateral. The lender bases their decision on your credit score, income, and other factors. Interest rates are higher than secured loans, but you avoid the risk of losing your home if you default.
You can use a home improvement loan for all kinds of projects including
- Kitchen or bathroom remodel
- Finishing a basement
- Replacing the roof
- Upgrading windows and doors
- Installing a pool
- Deck or patio addition
- Landscaping
- And much more
The application process is quick and funding can be fast, often within a few days of approval. These loans are offered by banks, credit unions, and online lenders. Shop around to compare interest rates. Approved loan amounts depend on your creditworthiness.
Pros of Home Improvement Loans:
- Unsecured – your home is not at risk
- Quick and easy application process
- Funds available in days
- Fixed interest rates and terms
Cons
- Higher interest rates than secured loans
- Smaller loan amounts
- Short repayment terms
Overview of HELOCs
HELOC stands for home equity line of credit. It uses the available equity in your home as collateral. A HELOC works like a credit card – you’re approved for a set limit and can draw money as needed up to that limit. It’s a revolving account, so as you pay down the balance, that available credit can be used again.
The amount you can borrow depends on how much equity you have. Lenders typically approve borrowers for up to 80-85% of their equity. Interest rates are variable and tied to a benchmark like the prime rate. You only pay interest on the amount borrowed. When you pay off the balance, the account can be closed or remain open.
HELOCs have drawn periods of 10 to 20 years where you can access the funds. After the draw period ends, HELOCs enter a repayment period of 10 to 20 years to pay back the balance. Average HELOC rates today range from 5% to over 8% APR.
HELOCs tend to have lower rates than other financing options. But keep in mind the rates fluctuate, exposing you to some risk. There are often no closing costs or fees to open a HELOC.
You can use HELOC funds on any home improvement project, such as:
- Major renovations
- Room additions
- Swimming pool installation
- Solar panel system
- Driveway or garage addition
- And more
Pros of HELOCs:
- Typically lowest interest rates
- Revolving credit line
- Often no upfront costs
- Interest may be tax deductible
Cons:
- Variable rates can rise over time
- Credit line can be frozen or reduced
- Risk of foreclosure if payments are missed
- Upfront appraisal fee may apply
Now that we’ve covered the basics of each option, let’s compare them across a few key factors:
Interest Rates
Interest rates are a major point of difference. HELOCs tend to have lower rates than home improvement loans. As of July 2022:
- Average HELOC rates range from 5% to over 8%
- Home improvement loan rates range from 6% to 36%
HELOC rates are tied to the prime rate, so they move up and down over time. Home improvement loans have fixed rates that stay the same over the full repayment term.
It’s cheaper to borrow with a HELOC when interest rates are low. But if rates trend up, the interest cost grows. A fixed rate loan protects you from increases.
Loan Amounts
HELOCs allow you to borrow much more than a home improvement loan. Limits are based on your home equity, and many lenders will approve you for up to 80-85% of your available equity.
For example, if your home is worth $300,000 and you owe $150,000 on your mortgage, you have $150,000 in equity. So you could qualify for a HELOC around $120,000 to $130,000.
Home improvement loans max out around $100,000 usually and tend to be from $1,000 to $50,000. So HELOCs are better for big projects.
Fees
One perk of HELOCs is they often charge no upfront fees. You may just pay a small appraisal fee. Home improvement loans don’t have closing costs, but you may pay an origination fee of 1% to 6% of the loan amount.
For a $20,000 home improvement loan at 4% origination fee, you would pay $800 in fees. On a HELOC, you’d potentially pay none.
Access to Funds
HELOCs give you access to a revolving credit line over a draw period of 10 to 20 years. You can draw as needed up to your credit limit and repaid amounts become available again to borrow. It offers flexibility to complete projects in stages.
Home improvement loans fund a lump sum upfront. If your project goes over budget, you’d need to apply for another loan or find other financing to cover extra costs.
Payments
HELOCs have flexible monthly payments during the draw period. You only need to pay interest on what you borrow. The minimum is usually interest plus 1% of the balance.
Home improvement loans have fixed monthly payments of principal and interest. The fixed payments provide predictability in budgeting. HELOC payments vary based on rate fluctuations and how much you borrow.
Qualifying Easier
Qualifying for a HELOC is often easier than qualifying for a personal loan. Lenders mainly look at your equity, though your credit score does matter. Typically a 620 FICO score is required for the best HELOC rates.
To get approved for a home improvement loan, you need good to excellent credit (690+ FICO). Requirements are stricter because the loan isn’t secured by property. Your income and debts are scrutinized.
Tax Benefits
A possible advantage of HELOCs is the interest may be tax deductible if used for home improvements. You can deduct interest on up to $750,000 of combined mortgage and HELOC debt on primary and secondary residences. Home improvement loan interest is not deductible.
Time to Get Funds
One of the nice perks of home improvement loans is the quick funding. Once approved, you can have the money deposited in your account within a few business days.
HELOCs take significantly longer to close because of the secured nature against your home. It takes several weeks to get an appraisal, process paperwork, and complete closing requirements.
So if you need funds ASAP for a small home project, a home improvement loan may be the quickest option.
Risks
With a HELOC, your home acts as collateral, meaning foreclosure is a risk if you fail to repay the debt. It’s a risk to consider.
A home improvement loan is unsecured, so your home is not in jeopardy if you default. The lender can’t seize your house but could pursue other legal action against you.
When a Home Improvement Loan Makes Sense
A home improvement loan usually works best when:
- Your project is small, under $20,000
- You need funds quickly
- You don’t have enough home equity for a HELOC
- You have good credit (690+ score)
- You want predictability of fixed payments
When a HELOC Makes Sense
You may want to consider a HELOC if:
- Your project is over $20,000
- You want the lowest rates and costs
- You have sufficient equity in your home
- You want flexible repayment options
- Your credit score is at least 620
- You may qualify for tax deduction benefits
Compare Options from Lenders
The best way to decide between a home improvement loan or HELOC is to compare options from lenders. Apply for both types of financing and evaluate the specific terms you are offered. Comparing the rates, fees, and other details can make it clear which route is more advantageous.
Every situation is different. Your financial qualifications, amount needed, and risk tolerance should factor into whether a home improvement loan or HELOC is better. Weigh
What is a home equity loan?
Home equity loans are secured loans that use your home as collateral. These loans carry lower interest rates than other borrowing options, have long repayment periods and even have tax advantages when used for eligible home improvements.
You may also qualify for more money than you would with other loans. The equity youve built in your home is equal to its current market value minus the amount you still owe toward your mortgage. And if youre one of many Americans whose home price has increased in recent years, you may be eligible for more than you think.
Just be careful taking on a larger home equity loan than you can handle. Not only is it a lot to repay, but you could risk losing your house.
“Fluctuating home values will impact the maximum loan amount since loans are based on a maximum percentage of home value,” says Gregory Crofton, CFP, founder of Adap Tax Financial. Though you may be able to qualify for more, Crofton recommends limiting your total home equity indebtedness to 75%. “Too many borrowers overextended themselves in the early to mid-2000 and ended up losing their homes,” he warns.
Start using your home equity today and see top rates you can qualify for here.
What is a home improvement loan?
Home improvement loans, unlike home equity loans, are unsecured personal loans. As a result, they can be more expensive — but if you have great credit (and shop around for the best rate) you may be able to find an APR thats comparable to home equity loans.
The amount you are eligible to borrow is also different under a home improvement loan. Instead of the value of your home equity, the lender will consider a number of factors in your application — including your credit history, existing debts and more. Among the home improvement loans we found, many start around $1,000 and go up to around $100,000.
Home improvement loans can make good alternatives if you dont want to use your home as collateral toward a renovation project. But consider how much the interest rate you qualify for could add to your total amount owed over time, and whether you can qualify for as much money as you need for your project before you decide.
HELOC Vs Home Equity Loan: Which is Better?
FAQ
What is the difference between a home improvement loan and a HELOC?
Is a home equity loan a good idea for home improvement?
Is there a better option than a HELOC?
Can a HELOC be used for renovations?
Should you use a HELOC to finance a renovation?
Often homeowners use HELOCs to finance major renovation projects, as the interest rates are lower than they are on personal loans and credit cards. That’s because you can continually build equity as you live in your home and then access your home equity when you need it with a home equity loan or HELOC.
Is a HELOC better than a home equity loan?
Both home equity loans and home equity lines of credit (HELOCs) have their advantages and considerations.Let’s explore the differences: 1.**Home Equity Loan (HEL)**: – **Fixed Structure**: A home equity
What are home equity loans & home equity lines of credit (HELOCs)?
Here is a list of our partners. Home equity loans and home equity lines of credit (HELOCs) are loans that allow you to convert some of your home’s equity into cash. These loans have similar benefits — for example, both HELOCs and home equity loans have relatively low interest rates because they’re backed by your home.
What is the difference between home equity loan and home improvement loan?
Home Equity Loan vs. Home Improvement Loan: What’s the Difference? Your equity and the size of your project can help you choose A home equity loan is a secured loan best for large projects with a long timeline. A home improvement loan is an unsecured loan for small, shorter projects.