Ever since you stepped across the threshold at the first open house, you’ve been in love with your cozy, turn-of-the-20th-century Craftsman. Your spouse loves its sheltered porch; you can’t get enough of the ageless walnut woodwork. You don’t regret buying an older house, but you have no illusions that the place is perfect. Lately, you’ve begun to realize your growing family needs a bigger, more modern space.
Your search for a larger, new construction home in your area, but the market is way too hot, and post-World War II housing stock just doesn’t have the same charm. So you settle on a compromise: finishing your current home’s cinder-block basement. At about $15,000, it won’t be cheap, but it’ll definitely be more affordable than a bigger house.
There’s just one problem. You’d have no problem dipping into your personal savings to cover the down payment on another house since you’d recoup the funds once you sold your current house. You’re aware that a finished basement will probably boost your home’s resale value in the long run, but you won’t see that boost anytime soon. After all, the whole point of this project is to keep your family in the home for years to come. And because you used a low-down-payment FHA loan to purchase the property, you lack the requisite equity to draw on a home equity line of credit (HELOC).
Are you out of options? Not necessarily. If you have decent credit, you may qualify for an unsecured personal loan with few strings beyond the obligation to make monthly installment payments. For homeowners without sufficient equity, a major home improvement project is a legitimate reason to get a personal loan – one that may be more fiscally responsible than using a personal loan to pay for a vacation or wedding, for instance.
How Home Improvement Loans Work
A home improvement loan, through a company like Credible.com, is a personal, usually unsecured loan that’s intended to finance expenses related to home improvement projects. In practice, a home improvement loan is identical to personal loans taken out for other permissible purposes, such as debt consolidation, medical expenses, or business startup expenses.
Personal loan rates and terms generally don’t vary by loan purpose. Instead, they depend on the borrower’s creditworthiness, non-credit factors such as the borrower’s debt-to-income ratio, the lender’s underwriting standards, and prevailing benchmark interest rates.
Borrowers with excellent credit (FICO scores above 720 to 740) can expect personal loan offers with:
- Low origination fees, if any (likely below 2%)
- Low annual percentage rates (below 10% to 12% APR, including any origination fee)
- Longer terms (five to seven years)
- High borrowing limits (up to and including the lender maximum, often $35,000 to $40,000)
Borrowers with good credit (FICO scores above 660 to 680) can expect to qualify for personal loans with:
- Moderate origination fees, if any (likely below 4%)
- Moderate rates (below 15% APR, including any origination fee)
- Moderate terms (three to five years)
- Moderate borrowing limits (variable by lender)
If they qualify at all, borrowers with fair or impaired credit (FICO scores below 660) must steel themselves for short-term, high-rate loans with low borrowing maximums.
Comparing Home Improvement Loan Quotes
Every lender is different, so take the time to get several home improvement loan quotes from multiple lenders. Using a company like Credible.com will help with the process. You can get prequalified in minutes and receive quotes from multiple lenders.
Usually, completing an initial loan screener won’t affect your credit score. This is because lenders wait to “pull” your credit – temporarily decreasing your credit score – until you formally apply. Hopefully, you’ll only need to apply once after you’ve selected the most attractive loan offer.
Over the course of a multi-year installment loan, small tweaks to rates and terms add up. For example, let’s say you need to finance $15,000 in home improvement expenses. Here’s how you can expect your monthly payment and total financing cost to change based on different APRs and loan terms:
- 8% APR: With a 36-month term, your monthly payment will be $470.05, and total interest charges will be $1,921.64. With a 60-month term, your monthly payment will be $304.15, and total interest charges will be $3,248.75.
- 11% APR: With a 36-month term, your monthly payment will be $491.08, and total interest charges will be $2,678.91. With a 60-month term, your monthly payment will be $326.14, and total interest charges will be $4,568.18.
- 14% APR: With a 36-month term, your monthly payment will be $512.66, and total interest charges will be $3,455.92. With a 60-month term, your monthly payment will be $349.02, and total interest charges will be $5,941.43.
- 17% APR: With a 36-month term, your monthly payment will be $534.79, and total interest charges will be $4,252.47. With a 60-month term, your monthly payment will be $372.79, and total interest charges will be $7,367.32.
Independent of interest rates, shorter loan terms generally mean lower total interest charges and higher, but fewer, monthly payments. Longer loan terms mean higher total interest charges and lower, but more numerous, monthly payments.
How to Use a Home Improvement Loan
If you’re diligent and organized, you can almost certainly complete your home improvement project with plenty of time to spare in your loan’s term. Even major home improvements, such as a kitchen remodel or accessory dwelling unit construction, can be completed in a matter of months under professional supervision.
How you use your home improvement loan’s proceeds depends on how you tackle your home improvement project. You have two options:
DIY Projects: Pay Home Improvement Expenses Directly
This method works well for DIY projects that involve lots of trips to the home improvement superstore and multiple orders placed with materials vendors. In this scenario, your loan is funded before you make your first home improvement-related purchase. Moving forward, you pay home improvement bills as they’re incurred or come due.
For example, a driveway installation might involve expenses such as:
- Renting paving equipment
- Renting digging tools for drainage
- Buying pipes or liners for drainage
- Buying multiple types of material for layered surfaces
Each of these line items – and others arising in the course of a custom project – would require a separate outlay paid out of your loan’s proceeds. For simpler, shorter-duration projects, you’ll likely make these purchases within a month or two of receiving your loan’s proceeds, after which you’re free to focus on paying down the loan’s balance.
Contractor Projects: Pay Vendor Bills at Project Milestones
This method works better for projects completed by a contractor, which usually have large bills at key project milestones – often an upfront deposit equivalent to 25% to 35% of the estimated total bill, and then a final bill for the balance. If you’re cutting out the general contractor and managing subcontractors yourself, you’ll need to pay their bills directly as they begin and complete their parts of the project.
In this scenario, you wait to apply for your loan until your project’s first bills arrive. This minimizes pre-project payoff time and maximizes your loan’s purchasing power.
This strategy raises the likelihood that your loan’s proceeds will last through longer, bigger projects; a full kitchen remodel can easily take 12 months, for instance. Downsides include the risk of serious cost overruns, which are inherent in any major improvement project, and the risk that you won’t find a lender willing to approve your entire loan request.
Pro tip: If you’re planning to use a contractor, make sure you use a service like HomeAdvisor. They’ve picked out the best contractors in your area so you know you’re going to be satisfied with your investment.
Pros of Using a Personal Loan for Home Improvement
Although it’s not an ideal first choice, using a personal loan to fund your next home improvement project could pay off under the right circumstances.
1. The Project Could Pay for Itself
There are no guarantees in life, and definitely none in home improvement. But certain home improvement projects are more likely to pay for themselves – and perhaps more – through higher resale value.
- Remodeling your kitchen
- Adding or upgrading a bathroom
- Adding a deck
- Making energy-efficient upgrades, such as new windows and insulation (which also reduce homeownership costs)
Home improvement projects less likely to pay for themselves through resale value appreciation include:
- Adding a bonus room
- Adding a sunroom
- Adding an in-ground swimming pool
- Adding a garage
- Replacing a roof (though all roofs must eventually be replaced)
Calculating Your Project’s Value-Add
You can calculate your home improvement project’s value-add in one of two ways:
- Actual vs. Estimated Sale Price. This is the difference between your improved home’s actual sale price and the estimated selling price of an unimproved, otherwise identical home.
- Sale Price vs. Purchase Price. This method becomes less reliable over time, as market factors independent of the improvement – such as buyer demand and prevailing interest rates – also affect resale value. Plus, if you’ve been in your home long enough to accomplish multiple home improvement projects, you’ll have to account for their cumulative cost and value-add.
In either case, subtract the second value from the first. If the difference exceeds the total cost of your home improvement project, the project has a net financial benefit.
2. It Can Cover Urgent Repairs
You can save up for some home improvement projects if you don’t mind postponing them. But not all home improvement projects are voluntary. When a major appliance or feature – such as your furnace or roof – is on its last legs, you may not have the luxury of waiting to repair or replace it when you have more money.
Sometimes, you need to pay up front for truly urgent repairs. That may necessitate raiding your emergency savings, if it’s sufficient, or charging your credit card. In such cases, you can use personal loan proceeds to satisfy the short-term debt. Avoid interest on any credit card charges by completing your loan application before the first monthly bill comes due.
3. It’s Easier on Your Monthly Cash Flow
Using personal loan proceeds to defray your project’s cost over three to five years is far easier on your monthly cash flow than paying bills in full as they come due.
4. It Can Be Easier, Faster & Less Costly Than Alternatives
Applying for a first mortgage is much more time-consuming and costly than applying for a personal loan. The application process for a home equity loan (second mortgage) or HELOC is nearly as onerous.
Although home equity loan and HELOC closing costs aren’t quite as high as first mortgage closing costs, and they can generally be rolled into the loan balance, they significantly increase your total financing costs. Also, home equity lenders often require appraisals and title insurance, further slowing down the process.
5. You’re Not Constrained by Equity
If you capitalized on a low-money-down loan to purchase your home faster, you likely have a ways to go to reach the standard 85% loan-to-value threshold at which home equity lenders even consider approving home equity loan or HELOC applications.
Bad timing is another common cause of constrained equity. Even a solvent homeowner who puts the standard 20% down payment toward their home’s purchase price is vulnerable to a housing downturn. A 20% drop in appraised value is enough to wipe out their initial equity.
In either case, if you can’t rely on the equity in your home to secure a low-rate loan, a personal loan may be your only viable home improvement financing option.
Cons of Using a Personal Loan for Home Improvement
These are among the reasons to consider other options before settling on a personal loan – or tackling your home improvement project at all.
1. It May Impact Your Creditworthiness
This risk is inherent in any new credit account, but it’s particularly acute for borrowers managing high unsecured loan balances. Should things go wrong with your home improvement loan, your credit score could take a major hit. Even if the worst doesn’t happen, you may find lenders more skeptical after your loan is funded.
The biggest credit-related risk of a home improvement loan is the risk of missing payments. Should you become unable to make your monthly payments due to a sudden drop in income or assets, your lender may report your non-payments to the three major consumer credit reporting bureaus. Such items usually remain on your credit report for seven years and lower your credit score for the duration.
Although your debt-to-income ratio doesn’t directly affect your credit score, lenders prefer borrowers with ratios no higher than 50%; for many, the cutoff is 40%. Adding a major new credit account is certain to raise your debt-to-income ratio. If you’re already straddling the line, this could hamper your future borrowing plans.
2. Interest Charges Are Unavoidable
You can’t entirely avoid interest charges on installment loans. The loan’s amortization schedule shows the precise mix of principal and interest built into each scheduled payment. Even if a sudden windfall empowers you to pay off your loan in full after a single monthly payment, you’ll be on the hook for some interest.
By contrast, you avoid interest entirely when you pay off a revolving credit line before your statement due date.
3. Potentially Higher Interest Rates Than Alternatives
Well-qualified borrowers with low debt-to-income ratios, annual income above $100,000, and FICO credit scores above 740 can expect to qualify for unsecured personal loan rates as low as 6% to 8% APR, depending on the lender. As unsecured credit products go, that’s a great range. Well-qualified credit card applicants rarely do better than 10% to 12%.
However, because HELOCs and home equity loans are secured by the borrower’s home equity and thus present a far lower risk to lenders, their rates almost always undercut unsecured alternatives’. Well-qualified borrowers can expect home equity product interest rates to match prevailing mortgage benchmarks, which have been under 5% since the late 2000s.
4. Your Project May Not Pay for Itself
A home improvement project needn’t pay for itself to be worthwhile. If you really want to add a sunroom to a house you have every reason to believe is your forever home, then by all means, add that sunroom, resale value be darned.
However, if you’re banking on your project’s resale value boost to offset your investment, it’s crucial to calculate the likely value-add. That’s doubly true if you’re planning to turn around and sell your home soon after completing the project.
5. Your Project May Prove More Costly Than Estimated
Cost overruns and shoddy workmanship threaten all-cash projects as surely as projects financed with personal loan proceeds. But the threat is greater when your personal loan is scarcely sufficient to cover the project’s expected budget and you have a limited savings buffer to accommodate overruns or revisions.
If you must use an unsecured personal loan, build a substantial buffer into your funding request – say, 10% to 15% more than your project budget – and promptly pay back unused funds after the project’s completion. If you have the option to tap a home equity line, that’s preferable to dipping into emergency or long-term savings.
6. You May Not Finish Your Project
During our most recent home search, my wife and I walked through a house that was bigger than we needed, but it was priced right and had nice curb appeal. Everything looked great until we got to the half-finished kitchen, which looked through a gaping double-door-sized hole out to a dilapidated sunroom – which looked out on an extremely unsound detached garage.
The basement was a creepy warren of half-built rooms that had clearly just been dried out from a spring flood. The second floor was another unmitigated disaster, with too-low ceilings hemming in too-small rooms connected by weird half-steps. A claustrophobic staircase led up to what must have been a tiny attic concealed, ominously, behind a small locked door.
To this day, I’m curious to find out what went wrong in that house. I suspect it was an attempted flip – the buyer underestimated what it would take to get the house in selling shape, tried to do too much themselves, supplemented it with cut-rate substitutions, and then finally gave up and put the place on the market at a loss-making price.
Home improvement projects fail more frequently than you’d like to believe. Among other reasons, they fail because:
- Subcontractors skip out, leaving unfinished work
- Subcontractor mistakes prove too costly to rectify
- Unexpected issues arise and prove too costly to rectify or work around
- DIY projects are poorly organized or managed
- The project’s budget exceeds estimates to the point that it’s no longer financially feasible
7. You May Need to Put Up Collateral
Borrowers with strong credit typically qualify for unsecured personal loans with affordable interest rates, low origination fees, and longer terms.
Borrowers with impaired credit aren’t so fortunate. You may find that the only lenders willing to originate your personal loan require collateral sufficient to secure the loan – most often, the title to a car or recreational vehicle. Should your loan slip into serious delinquency – usually after 90 days of nonpayment – the lender may move to seize your collateral.
Alternatives to Using a Personal Loan for Home Improvement
Before applying for a personal loan to fund your home improvement project, consider these alternatives.
1. Start a Home Improvement Savings Fund
This is my preferred approach to home improvement financing because:
- There’s no credit risk.
- It’s easy to fit to budgets of virtually any size.
- It’s easy to adjust as financial conditions require (with contributions increasing and decreasing with your discretionary income).
- Once funded, it’s ready on demand.
When my wife and I added a patio to our backyard, we didn’t even consider paying $4,000 out of pocket. Instead, we raided the home improvement savings fund we’d built up over the prior couple years. Had we financed the full cost at 10% APR over three years, our monthly payment would have been about $130 – coincidentally, about equal to our monthly contribution to our home improvement savings fund.
Starting & Calibrating a Home Improvement Savings Fund
Pro Tip: Simple.com has a 2.02% APY and is currently offering up to a $500 bonus when you open an account.
Then, examine your budget (which you can set up through Personal Capital) and determine how much you can afford to put aside each month for future home improvement projects. Follow these guidelines:
- If you’re comfortable dialing back other types of savings, you can find the requisite funds by skimming from your emergency savings, long-term savings, and other savings to which you contribute regularly.
- If you’d prefer to increase your overall savings rate instead, you’ll need to tighten up your discretionary spending, pursue a side hustle, or find passive income opportunities.
- If you have a specific home improvement project in mind, price it out and determine how much you’d need to borrow to finance the entire project if it began tomorrow. Check your rates with multiple lenders, as if you were actually applying for the loan, and note the highest monthly payment your budget can bear on the highest-rate, shortest-term option. If you’re willing to part with that payment every month for the next few years, you can afford to put it into an interest-bearing savings account.
The Limitations of a Home Improvement Savings Fund
Your home improvement savings fund may not be enough to cover the entire cost of a major home improvement project, particularly one that can’t wait. It took us about three years of saving to zero out our patio project’s $4,000 price tag. At that pace, we wouldn’t expect to pay for a thorough kitchen remodel or structural addition with our home improvement fund alone.
2. Attack Larger Projects Incrementally
If you don’t have the luxury of waiting to build up a home improvement savings fund, tackle home improvement projects over time as your cash flow allows. Think of this strategy as building and draining lots of small, short-term home improvement savings funds – socking away $100 per month for four months, then hitting the home improvement store for equipment and supplies worth $390.
This strategy has some big advantages, namely no debt and limited impact on cash flow. But it requires organization and diligence that, to be frank, many DIY home improvement aficionados can’t pull off. With less capital to spare and more time to wait and waste, the risk of serious cost overruns or project delays is greater than in a loan-powered sprint to completion.
3. Use a Home Equity Loan or Line of Credit
For homeowners with sufficient equity, this is a great home improvement financing option because it offers:
- Low Interest Rates. Even the best-qualified personal loan applicants won’t qualify for rates as low as well-qualified homeowners can expect on HELOCs through Figure.com and home equity loans.
- Flexible Terms. HELOCs typically offer 10-year draw periods, which are ideal for longer-duration projects and phased projects for which the homeowner would prefer to make just one loan application. Home equity loans may have even longer terms, though you’ll want to weigh lifetime interest costs against the loan’s benefits.
- Potential Tax Benefits. If you itemize deductions, you may be able to deduct interest accrued on a home equity loan. Consult a tax professional for guidance on your personal tax situation.
Aside from the risk of losing your primary residence should you become delinquent, the biggest downside to home equity credit products is the onerous application process. This isn’t a last-minute financing option.
4. Use a Title I Loan
This option makes sense for smaller projects. A Title I Property Improvement Loan is a federally insured loan backed by the U.S. Department of Housing and Urban Development (HUD).
Since they’re federally insured, Title I loans are seen as less risky by the private lenders that issue them – chiefly banks, credit unions, and specialty mortgage lenders. Credit-challenged borrowers who don’t qualify for unsecured personal loans with favorable rates and terms may qualify for unsecured Title I loans, though every lender is different and approval isn’t guaranteed.
HUD insures Title I loans with principals ranging up to $7,500. That’s enough to finance small to moderately sized home improvement projects, but not big-ticket remodels. Larger loans must be secured by the property title. In all cases, the home must be finished and occupied for at least 90 days afterward.
5. Take Advantage of 0% APR Credit Card Promotions
This option is suitable for well-qualified homeowners seeking to finance relatively small home improvement projects.
To qualify for a 0% APR purchase promotion, you typically need a FICO score north of 680 to 700, as well as a consistent payment history, low credit utilization, and low debt-to-income ratio.
Your financing limit is technically your card’s credit limit, but you don’t want to get anywhere close to maxing out your card. Aim to keep your credit utilization ratio under 50% – for example, a balance of no more than $5,000 on a $10,000 credit limit. Avoid charging non-home-improvement-related purchases to your 0% APR card during the promotional period.
0% APR credit card promotions generally don’t last forever; the longest I’ve seen on a reliable basis is 21 months. If interest accrues retroactively, you must plan to pay off your entire balance before the promotion end date or face ruinous interest charges. Even if it doesn’t, it’s in your best interest to zero out your balance – or get it as low as possible – before the promotion runs out. You’ll therefore need to front-load your project-related purchases and spend the bulk of the promotional period paying them down.
6. Make a Homeowners Insurance Claim
This option is only appropriate for “improvements” necessitated by insurance-covered events, such as storm damage. Some assumptions are safer than others; for instance, most policies cover replacements for hail- and wind-damaged roofs, but water damage is less guaranteed.
Review your homeowners insurance policy to determine which events, home components, and repairs qualify. Check your deductible, which may vary by covered event or damage type, to confirm that it’s comfortably less than the estimated cost of the repair.
The biggest drawback of filing a homeowners insurance claim to cover the cost of a necessary home repair is the potential for higher premiums. According to CNN Money, premiums rise 9%, on average, after the first claim and 20% after the second claim.
For a massive repair, such as a total roof replacement, the cost of higher premiums is not likely to exceed the repair’s out-of-pocket costs, even after the deductible. The calculation is different for modest repairs, claims on which could be swamped by long-term premium costs.
7. Manufacturer & Contractor Financing
This option makes sense for DIY homeowners purchasing goods directly from manufacturers and wholesalers, as well as for homeowners working with reputable contractors that offer financing.
This type of financing is often secured by a lien, which gives the financing party a claim on a portion of the proceeds of the property’s eventual sale. Rates and terms vary, but secured financing products generally carry lower financing charges than unsecured products.
Keen-eyed readers may notice an apparent omission in the alternatives listed above. Where’s the entry for FHA rehabilitation loans, or 203k loans?
It’s true that 203k loans can be, and often are, used for home improvements. But they’re designed to finance the purchase and rehabilitation of fixer-upper homes, a more ambitious (and costly) purpose well beyond the capacity of the typical unsecured personal loan.
If you’re actively looking to buy a house in need of serious TLC, you should absolutely investigate whether you qualify for a 203k loan and, if so, consider applying. Had my wife and I decided to take a massive leap of faith and purchase that bizarre, half-finished house all those years ago, we certainly would have done so.
Are you thinking about taking out a personal loan to fund a home improvement project? Or does one of the other options we’ve outlined here make more sense for you?