What Type Of Home Improvement Loans Can I Qualify For?

Posted on April 29, 2021 in Loans

Home improvement projects and home renovations can be very expensive. Whatever it is that you may be looking to do, it will probably cost at least five figures. For example, the average kitchen remodel is more than $23,000, the average bathroom remodel is $21,000, and even a 16 x 20 wooden deck will cost $14,000 on average. 

While these project prices can sound a little intimidating, don’t be too worried or cancel your plans just yet. You won’t have to produce that kind of case directly out of your pocket, as there are lots of available options for home improvement loans that can help you to finance the cost of the upgrades, remodels, or repairs. 

Cash Out Refinance

One of the most popular ways to get money for home improvements is by doing a cash out refinance. Basically it works like this: you refinance to a new mortgage loan that has a bigger balance than what you currently owe on your mortgage. Then you would pay off your existing mortgage and keep the remaining cash. The money that you will receive from a cash out refinance comes from your home equity. It can be used to fund home improvements, but there are no strict rules in place that say cash out funds have to be used for this purpose specifically. 

When A Cash Out Refinance Is Best

A cash out refinance will often be the best if you are able to reset your loan at a lower interest rate than your current mortgage. You might even be able to adjust the loan term and pay off your home sooner. For instance, let’s say that you had 20 years remaining on a 30 year loan. Your cash out refinance could be a 15 year loan, which would mean you would be scheduled to pay off your home five years earlier than before. 

It’s a good idea to compare the costs over the life of the loan, including the closing costs. That means looking at the total cost of the new loan and comparing it to the cost of keeping your current loan for it’s duration. It’s important to remember that cash out refinances will result in higher closing costs, and they will apply to the entire loan amount, not just the cash out. As a result, you will likely need to find an interest rate that is significantly lower than your current one to make this option worthwhile.

Pros

  • Cash out will come from home equity
  • You continue with only one mortgage payment
  • You can lower your interest rate and loan term at the same time
  • You can spend the cash on anything 

Cons

  • Closing costs will apply to a large loan amount
  • New loan will have a larger balance than your current mortgage
  • Refinancing will start your loan over

FHA 203(k) Rehab Loan

An FHA 203(k) rehab loan will also bundle your mortgage and home improvement costs into a singular loan, but you won’t have to apply for two separate loans or pay closing costs twice. Instead, you will finance your home purchase and home improvements at the same time, whenever you buy the house. 

FHA 203(k) rehab loans are great for whenever you are buying a fixer-upper and know that you will need additional finances for the upcoming home improvements projects. In addition, these loans are backed by the government, meaning you will get a few special benefits, such as a low down payment, and the ability to apply despite having a less than ideal credit score. Along those lines, this makes buying a house after debt settlement much more accessible.

Pros

  • FHA mortgage rates are currently lower than average
  • Your down payment could be as low as 3.5%
  • Most lenders will only require a 620 credit score, possibly lower
  • You don’t have to be a first time home buyer

Cons

  • Designed only for older and fixer upper homes
  • FHA loans will include upfront and monthly mortgage insurance
  • Renovation costs must be at least $5,000
  • 203k rules will limit the use of case to specific home improvement projects 

Home Equity Loan

A home equity loan will allow you to borrow against the current equity that you have built up in your home. Your equity can be calculated by assessing your home’s value and subtracting the outstanding balance remaining on your existing mortgage.Unlike a cash out refinance, a home equity loan will not pay off your existing mortgage. If you already have a mortgage then you would continue paying its monthly payments, while additionally making payments on your new home equity loan. 

When A Home Equity Loan Is Best

A home equity loan is typically the best way to finance home improvements whenever you have plenty of home equity built up or you need funds for just a one time major project. A home equity loan is dispersed as a single payment upfront, with your home being used as collateral. That means that similar to a mortgage, lenders can offer lower rates because the loan will be secured against the property. 

This low and fixed interest rate will make a home equity loan a great option if you need to borrow a large sum of money. As you will likely be paying the closing costs on the loan, the amount that you borrow will need to make the additional cost worth it. Another benefit is that a home equity loan can possibly be tax deductible. 

Pros

  • Home equity loan interest rates are usually fixed
  • Loan terms can range from five to 30 years
  • You can borrow up to 100% of your equity
  • Great for large, one time projects like remodels

Cons

  • Will add a second monthly payment if you still owe money on the original mortgage
  • Most banks, lenders, and credit unions will charge origination fees and other closing costs
  • It’s only a one time lump so you will need to budget your projects carefully

Home Equity Line Of Credit (HELOC)

Another financial option for home improvements is to use a home equity line of credit or “HELOC”. A HELOC is similar to a home equity loan, but it will work more like a credit card instead of a traditional loan. You will be able to borrow up to a pre approved limit, pay it back, then borrow from it again if needed. 

Another key difference between home equity loans and HELOCs is that HELOC interest rates are adjustable, meaning they can both fall or rise over the term of the loan. However, interest will only be due on your outstanding HELOC balance, the amount that you’ve actually borrowed, and not on the entire line. At any time you could choose to use only a portion of your total credit line, meaning that your payments and interest charges would be lower.

When HELOC Is Best

Due to the critical difference, a HELOC might be a better option than a home equity loan if you have a less expensive or long term project that will require ongoing financing. Some other crucial factors of HELOCs include:

  • Your credit score, income, and the home’s value will all determine your total spending limit
  • HELOCs will come with a set loan term, typically between five and 20 years
  • Your interest rate and loan terms can change over time
  • Closing costs are minimal 

Pros

  • Payments will vary depending on amount borrowed
  • Revolving balance means that you can re-use the funds after repayment
  • Minimal closing costs

Cons

  • Loan rates are often adjustable, meaning that both your rate and payment can increase
  • The bank or credit union can change the repayment terms
  • Rates will typically be higher than they are for home equity loans

The Takeaway

There are plenty of options for home improvement loans, most of which have little to no requirements if you are a homeowner and have some equity. It will be up to you to decide whether you should do a cash out refinance, HELOC, FHA 203(k), or a home equity loan based on your specific financial details.

If you don’t have very much equity in your home, you may have to take out a personal loan or use a credit card in order to perform your home improvements. If this is the case, it may be wise to put off the repairs until you have a little more equity, if you can. Personal loans and credit cards will get you the financing that you will need for smaller projects, but it can be a little pricey trying to repay them and may end up doing some damage to your credit.

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