A guide for understanding home improvement loans

Whether you’re doing a major remodel or renovating just the bathroom, having a game plan to come up with the funds is a good starting point. We’ll go over several types of home remodel loans. You’ll be better prepared once you understand the ins and outs of the several home improvement loan options.

What is a home improvement loan?

There’s no one home improvement loan. Rather, you’re choosing between several financing options that could allow you to pay for home improvements big and small:

• Installing a new roof
• Replacing an outdated HVAC
• Fixing a damaged plumbing system
• Buying new furniture
• Adding or updating rooms
• Building a new garage
• Installing a home addition
• Funding a DIY renovation or overhaul
• Upgrading kitchens and bathrooms

While some of these require a significant upfront investment, there are targeted upgrades you can make that could increase the value of your home. These include adding a new deck, updating old appliances, doing marble countertops or redoing the kitchen floor.

How home improvement loans work

Because there’s no specific home improvement loan, the way they work is a little bit different depending on the choices available to you. Loans secured by the home itself will have lower interest rates than personal loans because the lender can rely on the collateral as a security for the loan. But personal loans offer a quicker funding process while not having to pledge your home.

Even among secured loans, there are differences. Cash-out refinances, home equity loans and the like are based on the current value of the home. By contrast, a rehab loan contemplates the value after the upgrades you make.

Steps to apply for a home improvement loan

The process involved in getting a home improvement loan is going to vary depending on the loan you end up going with while this is an outline of what you might expect, not everyone loan features all of these elements.

1. Have a good idea of what you’re trying to accomplish. Once you can describe the project and its scope, it’s much easier to go get cost estimates. Contractors can only give you a projection based on the information you give them.
2. Compare your loan options. Once you have a good idea of the cost based on selecting a professional to work with, this will help you narrow down your financing options. Make sure you compare rates and monthly payments but do so apples to apples. You won’t want to compare personal loans to home equity loans.
3. Get your documentation ready. No matter which loan option you choose, your lender will have to qualify you. This involves a credit check, but also getting income and asset documentation from you. Think tax returns, W-2s, pay stubs and account statements.
4. Apply. If you’ve collected all the documentation in advance, the application should be straightforward. You can usually do this online.
5. Get an appraisal. If you’re getting a secured loan, the home gets evaluation to determine how much the lender can give. This may be an appraisal, but occasionally alternatives are used. This doesn’t apply to personal loans.
6. Close on the loan. This is when you pay the closing costs and sign for the funding. You’ll have to bring your ID and a cashier’s check or be prepared to set up a wire transfer in many cases.
7. Get funded. If you’re refinancing or doing a home equity loan on your primary property, you have a right of rescission that lasts 3 business days if you change your mind on the loan. But from a practical perspective, this also means you have to wait for funding.
8. Get any required inspections. If you get a rehab loan, these are often funded in stages. You receive additional money for the project as work is completed. Inspections are the checkpoint for the loan servicer.

5 types of home Improvement Loans

While we’ve gone over home-improvement loans in general and what to think about, it’s time to delve into the options available to you.

1. home equity loan

Home Equity Loans allow you to convert a portion of your existing home value into cash without touching your existing mortgage. ¹ The rate is higher and a second mortgage than your first mortgage. Home Loan Experts will help you with a blended rate calculation, because if your rate is small enough, you can save money with a smaller balance at a higher interest rate compared to a cash-out refi. You have two payments.

2. Home Equity Line Of Credit (HELOC)

Like a home equity loan, a home equity line of credit (HELOC) is a second mortgage turning your home equity into cash. Instead of being a lump sum payment, it works like a credit card initially. You can take funds out and put them back in for reuse, but you’re only required to make the interest payments. During the repayment period, the balance freezes and you pay back principal and interest. Rocket Mortgage^® doesn’t do HELOCs.

3. Cash-out refinance

Unlike the preceding options, you access your home equity in a cash-out refinance by taking a higher loan balance on your existing mortgage. Because of this you’ll get a lower interest rate than you would on a second mortgage and you have one payment. It changes the terms of your mortgage. You’ll have to see which way the numbers work out most favorably. Home equity loans or lines of credit may allow you to access more equity.

Example of cash-out refinancing

With a cash-out refinance, you can typically only convert up to 80% of your home value into cash. The exception is VA loans, but you have to meet eligibility requirements for military service time, he discharged due to a disability or a surviving spouse. The home equity loans from Rocket Mortgage allow conversion for all but 10% of your equity.

Let’s say you’ve paid off $200,000 on a $400,000 home. Because 80% of 400,000 is $320,000, you can use a cash-out refinance for a project with up to $120,000. A Home Equity Loan could allow you to access $160,000 based on being able to finance up to 90% of your home value. The more equity you have built up, the more flexibility you have.

4. Personal loans

Personal loans tend to be shorter-term loan options of 3 – 5 years that have no collateral associated with them. Because the loan is based solely on your credit history, it has a higher rate than anything tied to physical property. However, they are flexible and can be used for anything, including home improvements. You can apply for a personal loan for between $2,000 – $45,000 from Rocket Loans?.

5. Rehab loans

Rehab loans build the cost of renovations into your loan amount. With a rehab loan, you may work with a contractor to draw up the plans and that’s what the appraisal is based on. Requirements vary by investor. For example, FHA rehab loans have two different limits for the cost of renovations depending on whether structural changes are required. Others allow for variation in the kinds of improvements that can be done.

Factors to consider which type of home improvement loan is right for you

There are several factors you might consider in determining which type of home improvement loan (if any) is right for you:

• Amount of equity you’ve built: If you haven’t built up much equity, a personal loan may be the way to go to get the funding you need. If you have equity you can access, a cash-out refinance home equity loan or HELOC all tend to offer better rates.
• Type of home improvement project: If you have one project in mind, you might go with a home equity loan or cash-out refinance where the funding is one cash payment. If you have several projects, a HELOC might be better because during the draw period, you can pull out funds and put them back is needed
• Your credit score: Regardless of the loan option picked, you’ll receive a lower interest rate with a higher credit score than you would if your credit history has a few dings on it. If your credit isn’t where you want it to be, working on it before applying may also expand your loan options.
• Type of loan: Cash-out refinances and home equity loans typically have the option for a fixed-rate. Because HELOCs work more like a credit card, these are variable and can change every month. Personal loans have fixed rates, but these are higher than the other options because there’s no collateral.

The most important thing to keep in mind when researching options is to make sure you can both accomplish your goals and afford the payment.

Pros and cons of home improvement loans

Before moving forward, consider the benefits and drawbacks of using a home improvement loan:

Pros

• There’s the flexibility to use them for a variety of home repairs, upgrades and additions.
• Depending on what you’re trying to do, the funding timelines can be very quick, particularly with personal loans. Home equity loans and HELOCs also frequently use quicker appraisal alternatives.
• The number of options should make it easy to shop around for the best possible fit and terms.

Cons

• You may have to take a second mortgage to get the funding you want for your projects.
• If you default on your payments when your home is collateral, it could be put at risk.
• There are higher interest rates attached to certain options like personal loans.
• Lower credit scores and riskier financial histories could limit your loan options.

The bottom line: You have home improvement loan options

Several different financing options could be classified under the banner of “home improvement loan.” If you’re looking to do a remodel renovation, utilizing your home equity could make sense if you’ve been in the home long enough to build up that resource. If you don’t have as much equity as you would like, a personal loan might make sense. These offer fast funding, but they have higher rates because they’re unsecured.

If you’ve weighed everything and you think a Home Equity loan or cash-out refinance is right for you, apply online with Rocket Mortgage.

¹ Home Equity Loan product requires full documentation of income and assets, credit score and max loan-to-value (LTV), combined loan-to-value (CLTV), and home equity combined loan-to-value (HCLTV) ratios. Requirements were updated 2/5/2024 and are tiered as follows: 680 minimum FICO with a max LTV/CLTV/HCLTV of 80%, 700 minimum FICO with a max LTV/CLTV/HCLTV of 85%, and 740 minimum FICO with a max LTV/CLTV/HCLTV of 90%. Your debt-to-income ratio (DTI) must be 50% or below. Valid for loan amounts between $45,000.00 and $500,000.00. Product is a second standalone lien and may not be used for piggyback transactions. Product not available on Schwab products. Guidelines may vary for self-employed individuals. Some mortgages may be considered “higher priced” based on the APOR spread test. Higher priced loans are not allowed on properties located in New York. Additional restrictions apply. This is not a commitment to lend.