How Do Home Improvement Loans Work?

Kali Hawlk Home Equity, Home Ownership 0 Comments

How Do Home Improvement Loans Work

Being a homeowner comes with a never-ending list of ways you wish you could improve your “home sweet home.” But upgrades and updates get expensive, and you already have a lot of demands on your budget.

With a limited amount of money — or at least, with a lot of competing financial priorities — most homeowners don’t have the cash available to make their preferred home improvements a reality.

But there’s another option: if you don’t have the cash available, you might consider a home improvement loan, which could allow you to make the renovations you want now and pay for them in a manageable way over time.

Is this a good idea? Here’s what you need to know about how home improvement loans work — and how to determine if one is right for you.

What Is a Home Improvement Loan?

A home improvement loan is exactly what the name suggests: it’s money you can borrow to improve your home now. Then, you can pay for that cost over a period of months or years.

Instead of paying in cash for an upgrade or project, you can finance it instead. Just be aware that requires paying interest on the money you borrow, making it a more expensive option overall than simply paying in cash.

If you feel your home improvement project will increase the value of the property and your enjoyment of the home, you might decide that paying interest is worthwhile.

Because home improvement loans are specifically designed to help you, well… improve an aspect of your home, you’ll need a few pieces of information when you go to the lender to apply for one.

How to Apply and Qualify for a Home Improvement Loan

First, you need equity in your home. Equity is the difference between what you owe on your home and what your home is worth. Most lenders want to see at least 20% equity before they allow you to borrow money against it.

Next, you’ll need a great credit history and score. While many lenders will underwrite a home improvement loan even if you don’t have the best credit, you’ll have to pay for it — literally. The lower your credit score, the higher your interest rate will be on the loan.

You’ll also need to show your proof of income. The lender wants to ensure you can reasonably afford to repay your loan — even if you do have equity in your home.

Finally, you need to have estimates from any contractors you want to work with. Developing an overall project budget will help, too. This shows the bank how you plan to use the borrowed funds. And it helps you understand how much you actually need. Some lenders will allow you to borrow more than you ask for, but that doesn’t mean you need to take them up on their offer. Remember, the more you borrow, the bigger your monthly payments on the loan will be — and the more you’ll pay in interest.

The Advantages of Borrowing for Home Improvement

A home improvement loan is a form of debt. Again, that means paying back the money you borrowed in monthly installments and with interest.

That might be worth it, considering the advantages of a home improvement loan:

  • Lenders offer competitive rates on home improvement loans, and borrowing money this way could be a cheaper option than trying to finance a project on your credit card.
  • You may add value to your home through the project you implement with your borrowed funds.
  • It provides you with a more immediate way of dealing with a serious problem. Yes, you do need to pay the money back — but it’s far better to borrow and handle a necessary repair than to wait and end up with more damage to your home.

However, it’s not all positive when you get a home improvement loan.

Yes, There Are Downsides, Too

Don’t forget, home improvement loans can backfire. Not all improvements boost home value. Some homeowners can even (inadvertently, of course) devalue their homes through anything from poor taste to shoddy construction work.

And interest rate charges aren’t the only costs involved. Just like any other loan, you’ll need to pay closing costs or origination fees.

Plus, renovations can quickly spiral beyond the initial scope of work. You need a backup plan as to what you’ll do if the project cost exceeds the amount of money you borrowed. Otherwise, you’ll not only have a lot of money to repay — but you’ll need to come up with even more to complete your improvement.

Look for Alternatives to Fund Your Improvement Projects

If you’re not comfortable with the idea of taking on debt, especially considering the downsides and risks, you should know that home improvement loans are just one option. They’re far from the only financial program available to you.

One alternative is to use a home ownership investment like the ones offered by Unison. The Unison HomeOwner program gives homeowners a way to pay for home improvements without a loan. There are no monthly payments on the funds provided. Instead, Unison hopes to earn a return on their investment when you sell the home.

It’s a great way to get all the benefits of home improvement loans without taking on additional debt that makes renovations even more expensive than they already are.

About the Author

Kali Hawlk

Staff Writer

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Kali is a writer, content strategist, and consultant. She has many years of experience writing about personal finance and real estate. She appreciates the chance to educate people about home-buying.

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