Renovations with Home Improvement Loans

It might seem paradoxical, but many homeowners have accelerated their home improvement plans due to increased free time, thanks to the Covid-19 pandemic. A Harris Poll [1] found that 34% of homeowners who initiated home improvement projects since March 2020 actually started sooner in light of social distancing practices like working from home.

Financing Your Home Improvement Project

Naturally, your enthusiasm for fixing up the old homestead will need to grapple with the reality of how to pay for it. Although home equity loans are probably the first alternative that springs to mind, in truth any loan used to pay for renovations is a home improvement loan. And frequently, loans that depend on the equity in your home are not the ideal financing solution, as can be seen by these challenges:

No equity: You bought the home recently and have not built much equity yet.
Don’t want a second lien: You don’t like the idea of adding a second lien on your home on top of your mortgage.
Don’t want to post collateral: You have relatively good credit and can borrow at an attractive interest rate without posting collateral.
Want to start right away: You don’t want to spend many weeks arranging an equity loan.
Want relatively short repayment term: You don’t want to spend the next decade or two paying off an equity loan.

If one or more of these factors apply to you, consider your alternatives. You can pay outright with cash, but do you have $15,000 to $45,000 lying around to pay for a modest renovation? Chances are, you’d have better uses of that money, especially in today’s uncertain environment.

For relatively small renovations, some folks turn to credit cards. But you may be looking at an APR exceeding 20%. Moreover, you need a high enough credit limit to fund the project. While you can certainly buy appliances, cabinets, materials, and supplies on your credit card, how will you finance any labor you hire. If you use a credit card cash advance, you’ll be looking at interest rapidly accruing from Day 1.

Which brings us to personal loans. These are also called signature loans because that’s the only thing guaranteeing your repayment. Let’s see how a personal loan addresses the set of factors listed earlier:

Equity: A personal loan does not depend on the equity in your home or any other type of collateral. With a personal loan, you don’t have to wait years to slowly build equity via an amortizing mortgage where interest costs are heavily front-loaded.
Lien: You don’t have to add another voluntary lien on your home to get a personal loan. If you default on a personal loan, the lender must first file a lawsuit and win the action before obtaining a judgement lien on the property.
Collateral: A personal loan depends on your creditworthiness, not the value of collateral. That’s an important consideration when you’d rather not put collateral at risk.
Speed: You can usually receive the proceeds of a personal loan within a week of applying. Home equity loans can take multiple weeks or months to arrange, time you could have spent on the renovation project.
Term: Most personal loans have terms from two to seven years, compared to 10 or more years for a home equity loan. That’s a plus if you’d prefer to keep the loan as short as possible (and minimizing interest costs).

Where to Get a Personal Loan

Personal loans are available online and at brick-and-mortar lending offices, such as the nearest branch of your bank or credit union. But many time-savvy consumers choose to shop online for a personal loan. It’s much more time-efficient, and you can prequalify without hurting your credit score.

Normally, when you apply for a home equity loan, the bank will do a hard inquiry on your credit report, which can drop your credit score by 5 to 10 points for a year. However, providers of online personal loans usually perform only a harmless soft inquiry during the prequalification stage. By prequalifying with several online lenders, you have the opportunity to rate shop without hurting your credit score.

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Using Your Home Improvement Loan

You are at liberty to fix up your home any way you choose, but we think it’s best to use both your heart and your head when deciding how to deploy your loan proceeds. Cosmetic renovations can make the place look nicer, but structural improvements add value to your home, increasing your equity in the property. It’s also more logical to start with the structural improvements – there’s no point in putting up wallpaper until you replace the wall’s underlying termite damage.

Experts put kitchen and bathroom improvements as the projects most likely to boost your home’s value. You can do a nice kitchen renovation for about $20.000, but your gain in home price might well exceed that amount. Of course, adding sweat equity will stretch your loan much further, and we’re told it’s very satisfying work!

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Eric Bank

Eric Bank is a business and personal finance writer who has been featured in Credible, Wisebread, CardRates, Zacks and many other outlets. He holds an M.B.A. from New York University and an M.S. in Finance from DePaul University.