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8/21/2022

How to get a home improvement loan

There’s nothing more exciting than standing in your home and dreaming about the different ways you could make it perfect. Adding a fourth bedroom, putting new flooring in the kitchen, picking out the perfect paint colors; it’s a lot of fun, and we’re here for it. So how do you make those dreams a reality? One popular way is through a home improvement loan.

What is a home improvement loan?

A home improvement loan is any type of loan you use to finance home renovations or improvement projects such as renovating your kitchen, replacing your roof, installing a pool, etc. They are available with most online lenders, credit unions, and local banks. On average, home improvements cost around $15,0001, but they can vary widely - anywhere from $5,000 to over $100,000.2 That being said, the type of project will decide how much you need. Once you have an idea of how much your project will cost, you’ll be able to choose the right loan for your situation.

Loans for Home Improvement

With so much going into home improvements, there isn’t a one size fits all solution for financing. While you have multiple loan options to choose from, a popular choice for many is a loan backed by your house – like a home equity loan. Here are some options that work well for different loan amounts and projects.

Home Equity Loans - Great for projects big or small

There are a number of things you can do with home equity and getting a loan for home improvements is one of them. Equity is the amount of your home’s value that is paid off and can be calculated by subtracting what you still owe on your mortgage from the value of your house.

For example, if your house is worth $200,000 and you have $125,000 remaining on your mortgage, just subtract $125,000 from $200,000 to get $75,000 in equity. That’s $75,000 that you could make if you sold your home today, and home equity loans allow you to borrow some of that equity to use now.

Benefit: Using equity to secure the loan can typically allow for longer repayment terms and better interest rates, leading to lower monthly payments.

You also create more equity to replace what you’re using if the loan is for renovations. For instance, if you take out $10,000 to remodel, but increase the value of your home by $10,000 with the improvements, then the equity you used for the loan is still there.

Drawback: The risk here is the possibility that the market could go down, meaning your home would decrease in value. If you take out equity and this happens, you could find yourself owing more than the home is worth – often referred to as being upside down on your house. If you plan on living in the home for a long time, this may not be as much of a concern, since the market will go up and down over the years and you plan on paying it down anyway. However, if the market is high right now, and you plan on selling in the next few years, getting a home equity loan may be risky.

Home Equity Line Of Credit (HELOC) - Good for multiple projects

Similar to a home equity loan, a home equity line of credit or HELOC can give you access to the equity in your home, but in a slightly different way. A HELOC will give you access to funds much like a credit card, which you can use when needed during the draw period. After the draw period, you will pay back what you used, with interest, though you could choose to pay it off anytime before the draw period is over.

Benefit: You don’t have to start paying on the line of credit right away, which works well if you aren’t sure how much will be needed to cover the project. You can also choose to use the line of credit for multiple projects if you pay it down quickly.3

Drawback: HELOC’s can be risky not only because of the fluctuating value of your home, but also because lines of credit normally come with adjustable interest rates. While the initial rate may be lower than on a home equity loan, it could go up over time, making your monthly payment harder to predict.

Personal Loans - Better for smaller projects and good credit.

Personal loans can normally be used for anything you choose, and to qualify, you rely mostly on credit and income. They are considered unsecured debt because they don’t have any collateral backing them like home equity loans or HELOC’s, which are backed by your home. Overall, if you want to get a personal loan, you’ll need to check your credit score, and confirm with your lender that the cost of the improvements isn’t more than they are willing to lend.

Benefit: Unsecured personal loans allow you to finance home improvements without losing any equity in your home. They also limit the risk of foreclosure if you default on your payments, since the loan isn’t secured by your home.

Getting a personal loan is usually a faster process than home equity options and terms are normally shorter, which means you could end up paying the loan off sooner.4

Drawback: Personal loans are riskier for banks because they have a harder time recovering any losses if you default. This can lead to higher interest rates, shorter terms, and higher monthly payments.

Cash-out Refinance - Works for any size project when interest rates are low

If you want to access the equity in your home, but avoid two different loan payments, a cash-out refinance could be a good option for you. It is similar to a home equity loan since it allows you to use the equity in your home for a project. The difference here is that while a home equity loan finances your equity and doesn’t affect your current mortgage, a cash-out refinance takes your mortgage and equity and lumps it all together into one loan. For this reason, you only want to go this route if interest rates are lower than the rate on your current mortgage. If not, you would end up paying a higher rate.

Benefit: You could end up with a lower rate on your mortgage and only one loan payment on your house.

Drawback: Pulling equity out of your home could result in owing more than it's worth if the market drops. This option is also only a good idea if rates are low, which may or may not be the case when you need it.

Other Ways to finance home improvement

Credit Cards

If you don’t have equity in your home and you can’t get a personal loan, a credit card may allow you to make any needed improvements. This could be a more expensive option in the long run, since credit card rates are usually higher than what you’d get with a loan.

Insurance Claim

When the repairs you need to make are a result of damage to the home, you could file a claim with your home insurance company. This would give you the funds needed to make repairs and help you avoid taking on new debt.

Savings

By far, the most common way that people finance home improvements is through savings. According to Bankrate, 76% of people used cash from savings to finance home improvements in 2019. If you know what you want to do with your home, and you have the patience to wait, saving for it over time is a great way to go. Even if you don’t think you can save everything you need, you could start saving up for part of what you need and then get a loan for the rest. This would allow you to borrow less and pay less in interest overall.

How to qualify for a loan

If thoughts of the new remodel have you anxious to get rolling, we can certainly help you get started. Before you come in, there are a few things you might want to know that will help you qualify.

A good credit score goes a long way.

Check your credit score before talking with a bank or credit union. It can let you know whether you need to improve your score before applying or if now is the right time. While banks may have different requirements, a good rule of thumb is to make sure your score is 620 or higher, with a higher score earning you better loan terms. Never checked your credit score?
No sweat. We’ve outlined how to monitor your credit, including where to get a free credit report, here.

Your debt to income ratio (DTI) needs to be 43% or lower.

All lenders will consider your income and compare it to the amount of debt you have. By dividing your monthly income by your total monthly payments on debt, you get what is called your debt to income ratio or DTI. This shows how much of your income is taken up by debt. Lenders will look for your DTI to be under 43% with some aiming for lower than 36%. If your DTI is too high, you can try to pay off some debt or increase your monthly income to get a loan.

You’ll need enough equity in your home.

If you’ve calculated the amount of equity you have in your home and it’s less than 15%-20%, then you may have trouble getting approved. This is because lenders will usually only lend up to 80%-85% of the value of your home. If you still owe too much on your home, you won’t be able to get a loan that uses your home equity as collateral, such as a home equity loan or HELOC.

Can you get more than one Home Equity Loan?

Maybe you're reading this from the comforts of your newly remodeled living room - paid for with your first home equity loan - and now you're thinking about doing more. Getting more than one home equity loan is definitely possible, so here are some tips if you're considering it.

Consider the Market – Since you’ve already used up some equity, you should consider whether or not you think the value of your home might go down in the near future. If you use more of the equity in your home with another loan, you could end up owing more than it’s worth if the value goes down. If you plan to sell in the next few years and you think the value of your home may decrease in that time, you may not want to choose another option for your next home project.

Try a different lender – If you’ve gone to the same lender with your mortgage and first home equity loan, then they may be reluctant to give another one, since they would be taking on even more risk with a third loan. Mortgage lenders try to avoid this type of situation, so you may have more luck with another lender.

Check out other types of credit – If the first loan you took out was a home equity loan, your next option might be to take out a home equity line of credit (HELOC). Lenders will sometimes be more willing to give out two different forms of credit than give more of the same.

Getting Started with Southern Bank

Our lenders are experienced in helping people like you get the loans they need to fix up their homes. Learn more about the loans offered by Southern Bank by finding a lender near you or giving us a call at (855) 452-7272.

Disclosures & References:

1Hanneh Bareham, How to Pay for Home Improvements, Bankrate, May 24, 2022,
https://www.bankrate.com/loans/home-improvement/how-to-pay-for-home-improvements/

2Brian O’Connell, What Are Home Improvement Loans and How Do You Get One?, TheStreet, Jul 2, 2018,
https://www.thestreet.com/how-to/home-improvement-loans-14638347

3Ben Luthi, How to Finance Your Next Home Improvement Project?, Experian, Feb 28, 2019,
https://www.experian.com/blogs/ask-experian/how-can-i-get-a-home-improvement-loan/

4Annie Millerbernd, How Do Home Improvement Loans Work?, Nerdwallet, Feb 3, 2022,
https://www.nerdwallet.com/article/loans/personal-loans/how-home-improvement-loans-work