Home improvement loans: how they work & how to get one

Home improvement loans are a type of unsecured personal loan. They're best if you have good credit and you’re doing a smaller improvement project.

Derek Silva

Derek Silva

Published May 29, 2019

KEY TAKEAWAYS

  • Home improvement loans have a fixed APR and terms of usually less than five years

  • You need good credit and a debt-to-income ratio of less than about 40%

When you want to make a home improvement or repair but don’t have the savings to cover the full cost, one option is to get a home improvement loan.

A home improvement loan is just a type of personal loan that you use to help pay for repairs, renovations, and other construction on your home. Like other personal loans, they come with a fixed annual percentage rate, or APR, and you repay them over a set repayment period. That period is typically five years or less, but you can find some loan terms of 10 years or more.

Home improvement loans aren’t perfect for everyone. They’re better for smaller projects and usually require you to have a strong credit history. We’ll cover whether a home improvement loan is right for you and some potential alternatives.

In this article:

How home improvement loans work

Home improvement loans are simply a subset of personal loans, and they work in much the same way as other short-term personal loans. You agree to a loan amount and repayment term upfront. Then you make regular payments until you’ve paid off the loan.

You can secure a home improvement loan from many of the same lenders who offer other loans. You may want to start by talking to your current bank or credit union. You may also want to consider getting an online loan.

The size of the loan you can get depends on multiple factors, but your credit plays a big part. Home improvement loans rarely reach $100,000 in value and most are less than $50,000. Loan repayment terms usually fall in the range of three to five years, but this varies by lender. You can find terms as short as one year and some lenders offer terms over 10 years.

Home improvement loans are also unsecured loans. That means you don’t need to have any form of collateral. A secured loan, like a mortgage, requires you to have collateral—property or some other asset—that the lender can take as payment if you cannot afford to pay back the loan.

What lenders consider when you apply for a loan

Lenders consider many factors when deciding whether or not to lend to you. Some of the major things they consider are

  • your credit score
  • your debt-to-income ratio
  • the cost of your home improvement project
  • personal information, like your job history

Your credit score

Your credit score and credit history are big factors when you apply for any loan. If you don’t have a good credit score, you will have a harder time securing a loan.

Generally, you will need a FICO score of at least 600. Some lenders will still lend to you if you have a lower score, but the minimum credit score is generally 580. Below that, you won’t qualify with most lenders.

Your debt-to-income ratio

Your debt-to-income ratio looks at all of your monthly debt payments versus your income. That includes car payments, student loans, and credit card payments.

Lenders consider this ratio because they don’t want to add to your debt payments if it’s going to overextend you and prevent you from paying back your loan. A debt-to-income ratio of less than 20% will get you the best interest rates, but you can still get loans with a ratio of just over 40%.

If your debt-to-income ratio is 50% or more, you likely won’t be able to get a home improvement loan at all.

To improve your debt-to-income ratio, pay down debt so that it decreases your total monthly payments. If you pay off some of your debt but it barely changes the amount of your monthly payments, you aren’t increasing your chances much when it comes to qualifying for a loan.

If you have any small monthly payments that you can quickly pay off, that may be a good place to start. At the same time, you probably want to focus on paying down high-interest accounts, like credit card debt. Here’s some advice to help you pay off your credit card debt faster.

The cost of your home improvement project

Before you apply, estimate the cost of your project. Give yourself some wiggle room because unexpected costs have a way of popping up during big projects, but don’t ask for much more than you need.

If your project will cost a few thousand dollars and you ask for a $20,000 loan, lenders may not award you the loan just because that’s a suspiciously high amount of money to request.

Other information lenders consider

A loan application will require personal information like your Social Security number, your income, information about your employer, your employment history, and information about your monthly debts.

Keep in mind that if you have frequently changed jobs in the recent past or if there are big gaps in your employment history, lenders may be wary of your ability to pay back a new loan. In some cases, talking with a lender either in person or over the phone can help you ease their concerns.

Interest rates on a home improvement loan

The APR you get depends on all of the factors mentioned above. They also vary by lender and change over time depending on other economic factors. Make sure to shop around and get quotes before you officially apply for anything.

As of May 2019, some of the best current APRs are about 5%. The higher end of the rates is more than 30%.

If you don’t have the best credit and you’re struggling to find a lender that offers a good APR, consider a federal credit union. Federal credit unions cannot charge an APR above 18%.

Alternatives to a home improvement loan

Because they’re personal loans, it’s hard to get a big home improvement loan unless you have excellent credit. If you’re looking for a bigger loan, there may be better options. Two of the most popular options, are home equity loans and home equity lines of credit (HELOCs).

Both of these work similarly and you may hear them referred to as a second mortgage.

Home equity loans

Home equity loans are usually a better option than a home improvement loan if have a lot of equity in your home and you’re spending on a big project, such as an addition to your home. Home equity loans have lower APRs than personal loans because you’re using your home as collateral. Loan repayment terms are also up to 30 years.

Unlike a personal loan, how much you can get from a home equity loan depends on the value of your home and how much equity you have. Some lenders allow a loan worth up to 85% of your home’s value. This is known as the loan-to-value ratio.

Example: Let’s say you bought a home for $200,000 and you still owe $150,000 on it. For a lender that allows loans worth up to 85% of your home value, the maximum loan available for your home is $170,000. However, the lender would subtract your remaining mortgage from the loan you can take. That leaves you with a maximum loan amount of $20,000 ($170,000 - $150,000).

The loan-to-value ratio only determines the maximum loan a lender would be willing to offer someone. Lenders still use other personal information, like your credit score, to determine if they will lend to you and what interest rates you will pay.

Home equity lines of credit (HELOCs)

HELOCs work much like a credit card. A lender gives you a credit line and you can borrow money, up to a maximum, when you need it. Then you pay back whatever you borrowed, with interest.

A HELOC gives you a lot more flexibility to spend money as you need it instead of having to request a lump sum up front. Because you only pay interest on what you borrow, you can also apply even if you don’t plan to start your home improvements immediately.

Some things to keep in mind with a HELOC is that lenders usually require you to have at least 20% equity in your home. Interest rates are also variable: Unlike a personal loan or a home equity loan, your APR could increase in the future.

If you’re considering unsure of whether a line of credit or a home equity loan is better for your situation, check out this breakdown of HELOCs versus home equity loans.

Cash-out refinancing

With a cash-out refinance, you refinance your mortgage for more than you actually owe on the home. The lender then pays you the difference between your mortgage and the loan. You can now use the cash for your home improvement project.

One big thing to consider with cash-out refinancing is that the cash you get from it may be less than you think. You will need to pay closing costs when you refinance. That can include an application fee, loan origination fee, underwriting fees, and taxes. On a $200,000 loan with $50,000 cash, you could end up paying 20% of the cash juast to cover closing costs.