Home Improvement Loans: Understanding Your Options & How They Work

A home improvement loan can be a great way to finance your renovation wishlist, but there are a number of different types and some can result in much higher monthly payments than others.

If you are planning to remodel, there’s a really good chance that you’re considering your options on how to finance it.

After all, a renovation can be expensive and it’s not uncommon for homeowners to need to find $100,000 or more to tackle their entire list of projects.

But let’s not forget that when you renovate, your home’s value typically increases. In fact, we estimate that an additional $75k is added for every $100k that’s invested.

And whilst there’s often confusion that surrounds home improvement loans, it doesn’t need to be this way.

In this guide, we’ll walk you through how these loans work and help you to understand your options, specifically looking at:

What Is A Home Improvement Loan?

Home improvement loans are a way to borrow money to finance renovations or additions.

But this isn’t just a single type of loan; despite what some lenders or banks might lead you to believe.

In fact, there are a number of different types of renovation finance that are marketed under the title of ‘home improvement loans,’ and this can make it incredibly confusing if you’re a homeowner looking to find the best way to pay for your project.

On one hand, some home improvement loans are actually home renovation loans that let you borrow based on your property’s after renovation value.

But on the other, many are nothing more than high-interest unsecured personal loans that will leave you struggling to borrow the amount you need and facing expensive monthly payments.

If you’re looking to take out a loan to finance renovation work, you need to make sure you’re carefully considering all of your options and that you choose the one that’s right for your specific project and financial situation.

After all, the type of home improvement loan that you go for can directly impact:

  • Your borrowing power
  • Your monthly payment
  • Interest rates
  • The payback period
  • Whether or not you need to refinance your first mortgage
  • Whether or not the loan’s interest is tax-deductible
  • The costs and fees associated with it

But finding the best way to finance isn’t easy, especially when there are so many different options marketed as the same thing.

Below, we’ll break down the different types of loans that fall into this category and help you to understand the pros and cons of each, making it easier to determine which is the best way to pay for your renovations.

What Types of Home Improvement Loans Are Available?

We want to take the confusion out of home improvement loans.

And first of all, this means understanding that there are a number of different types of loans that are described in this way, as well as other ways to finance renovations.

To help you compare the different options that are available, let’s take a look at each of these on their own, before offering up a side-by-side comparison to show how each one works and the differences between them all.

We’ll also compare the different types of home improvement loan with home equity loans (and HELOCs), given that these are commonly used to pay for home improvement loans, despite also having other uses.

Unsecured Personal Loans

We’ll come straight out and say it; most homeowners shouldn’t use a personal loan for home improvements.

But this is where things get a little confusing and complicated when talking about home improvement loans.

You see, a large number of the finance products that you see advertised as ‘home improvement loans’ actually aren’t a specialized method of renovation finance at all; they’re simply unsecured personal loans that are marketed to homeowners looking to finance a remodel.

Whereas renovation loans are specialist products that have been designed with home improvements or construction in mind, these are no different from any other personal loans other than the way they’re advertised.

You might also find credit cards marketed in this way, too.

Borrowing using a personal loan means that, in comparison to other options, monthly payments will be higher (due to higher interest rates and a shorter payback period), your borrowing power will be significantly less and the interest paid isn’t tax-deductible. Many also come with a steep origination fee.

That said, they may be suitable for those looking to borrow a smaller amount or who need the money immediately, just in most cases, there are better alternatives out there.

Home Renovation Loans

Home renovation loans are, for most homeowners, the most efficient way to pay for home improvements, given that they allow you to borrow based upon your home’s estimated future value, rather than having to rely upon the equity that has been built up.

You see, in almost all cases, your home’s value will increase when you undertake renovation work. And renovation loans let you tap into this value now, as opposed to options that don’t give you credit for the increased home value.

In fact, homeowners who have recently purchased may have to wait 10+ years to have built up sufficient equity to finance their entire renovation wishlist.

100k

Even the most basic renovations are out of reach for years when equity is your only leverage, which is why home renovation loans are such an attractive option.

But again, there isn’t just a single type of renovation loan to get your head around, and below we’ll dive deep into the four main options that you have available to you:

RenoFi Loans

A RenoFi Loan is the only type of renovation loan that doesn’t require homeowners to refinance their first mortgage, and this is a big deal for one main reason.

You see, many of us have locked in great mortgage rates in recent years, and refinancing means losing these, in turn leading to higher monthly payments.

If you’re looking for a way to finance your renovation project that gives you the highest possible borrowing power (often by more than 11x) at the best possible rates (equivalent to traditional home equity loans or line of credit) and lower fees, this is the perfect way to borrow. They come with terms of up to 20 years.

These loans also don’t require the funds to be disbursed to contractors through a messy inspection & draw schedule process, something that in itself means that many contractors hate construction loans.

tappable equity

RenoFi Loans have been designed as a specific way to finance renovations and to provide the ease of a home equity loan with the borrowing power of a construction loan, allowing you to borrow more and tackle your entire renovation wishlist in one go.

How do I know if a RenoFi loan is right for my project?

The RenoFi team is standing by to help you better understand how RenoFi Loans work and the projects they are best suited for. Have a question - Chat, Email, Call now...

Construction Loans

Construction loans were never originally intended to be used as a way to finance renovations, rather for the build of a home from the ground-up.

Until recently, however, there were few other options that allowed homeowners to borrow based on their home’s estimated future value, hence why they became recommended as a way to pay for home improvements.

But given that ground-up construction carries a whole load of risk, lenders put in place a stringent set of criteria that must be met, including requirements such as draw schedules and approvals, all of which add delays and extra work to the process.

Construction loans also add a requirement to refinance as well as higher closing costs and lender’s fees than other types of financing.

Want to know more? Read our guide on how construction loans work.

As far as we’re concerned, most people shouldn’t use a construction loan to pay for a renovation, for the simple reason that better options exist.

Fannie Mae HomeStyle Loan

Before RenoFi Loans came along, Fannie Mae HomeStyle loans were one of the most common ways for homeowners to buy and renovate in a single loan.

In fact, these government-sponsored construction loans let you borrow based on your home’s after renovation value, up to a maximum of 95% (just be aware that you’ll need to pay Private Mortgage Insurance (PMI) if you go above 80%).

And while these loans let you spread repayments up to 30 years, they typically come with higher interest rates than other construction loans, a requirement to refinance, and costs that make them one of the most expensive ways to borrow on the market from a fees perspective.

FHA 203(k)

FHA 203(k) loans are an alternative to Fannie Mae HomeStyle loans, being sponsored instead by the FHA, another government agency.

And one thing to point out is that, due to their affiliation with the FHA, the credit score requirement of these loans are typically lower than other types (making them the best way to borrow if you have a poorer credit score), as well as the ability to borrow up to 96.5% of a property’s future value.

But the interest rate on these loans is higher than all other types of renovation loans and also requires FHA mortgage insurance upfront and for the duration of the loan.

To help you to compare the different types of renovation loan, take a look at our handy side-by-side comparison table below:

Renovation Home Equity LoanSingle-Close Construction To Permanent Loan (CTP)Fannie Mae HomeStyle LoanFHA 203k (Full)Two-Close Construction To Permanent Loan (CTP)
Is this a mortgage?YesYesYesYesYes
1st or 2nd mortgage?2nd1st1st1st1st
Require refinance of existing mortgage?NoYesYesYesYes
Typical Interest RateMarketAbove MarketAbove MarketAbove MarketAbove Market
Loan Limit (Renovation Cost + Mortgage)$500,000Jumbos allowedConforming only$Conforming onlyJumbos allowed
Loan Term (max)20 years30 years30 years30 years30 years
Credit Score Required660+700+620+580+580+
Loan to ValueUp to 95%Up to 95%Up to 95%Up to 96.5%Up to 80%
Can be used for building new home?NoYesNoNoYes
Restrictions on type of improvements?NoNoNoYesNo

How Is A Home Improvement Loan Different From A Home Equity Loan, HELOC, or Cash-Out Refinance?

If you’ve built up equity in your home, financing renovations by tapping into this is common.

But the fact remains that it takes many years for most homeowners to build up enough equity to come anywhere close to being able to undertake the full list of renovations that they want to do.

And when there isn’t sufficient equity available, either because the house has only recently been purchased or that the costs involved exceed what can be borrowed, then this presents a problem.

This is where home improvement loans (at least renovation loans) stand out, in so much as they let you borrow based on your home’s after renovation value, therefore significantly increasing your borrowing power (with a RenoFi Loan, this can be up to 11x higher).

Traditional equity-based financing, on the other hand, only allows you to borrow based on your home’s current value.

Home Equity Loan

A home equity loan (also known as a second mortgage) lets you borrow a fixed amount of money based on the equity that you have in your home.

These loans typically come with a fixed interest rate (meaning your payments will stay the same each month) and give you the full amount upfront.

The main downside is that you must have tappable equity available, with most lenders letting you borrow an average of 80% Loan-to-Value.

By using a specific renovation loan, you could borrow a higher amount and tackle more of your wishlist.

Home Equity Line of Credit (HELOC)

A home equity line of credit (HELOC) is similar in many ways to a home equity loan, but rather than giving you a fixed loan amount, you’ll have access to a revolving line of credit up to a set limit.

You’re able to use as much or as little of your available line of credit as you need (during the available draw period), and will only pay interest on the amount that you’ve drawn on.

After the draw period (usually 5 to 10 years) will be a repayment period of 10 to 20 years.

And while the interest rate is usually lower than on personal loans or credit cards, interest rates will typically be variable, meaning that your monthly repayments will fluctuate.

As with a home equity loan, you must have tappable equity available to be able to fund renovations using a HELOC.

Cash-Out Refinance

A cash-out refinance allows you to refinance your first mortgage to release some of the equity that you have built up, using this to pay for a home improvement project.

Whereas a home equity loan or HELOC is a second mortgage, a cash-out refinance consolidates your first mortgage and the equity that you release into a single loan. This can mean you lose any great rates you’re currently locked into.

Again, you must have sufficient equity built up for this to be a viable option, and your borrowing power will be limited when compared with a renovation loan that allows you to borrow based on the after renovation value of your home.

Some homeowners (as an example, those who fixed their first mortgage on a much higher rate in the early 2000s) may find that a cash-out refinance is a good move, but this isn’t the best option for most people.

Why Take Out A Home Improvement Loan?

The right type of home improvement loan (but let’s make it clear, we’re not talking about unsecured personal loans that are marketed as these) can make it possible for you to tackle your entire renovation wishlist today, rather than having to wait 10+ years to build up sufficient equity to borrow based upon this.

Just think about it this way.

You’ve recently bought a new house but have a list of renovations you want to undertake to make it your forever home; the perfect space for you and your family.

This makes total sense. After all, if you’re buying a house in 2020, there’s every chance that the property is at least 40 years old and has elements that you want to change or update.

But renovations are expensive, especially when you want to remodel the whole house in one go.

You have three options:

  1. You reduce the scope of your project and renovate room-by-room, and project-by-project, over many years, living in a never-ending construction-zone in the process (however, doing so increases the cost of renovating as contractors give better rates on larger projects).
  2. You wait until you have built up sufficient equity and make do with your house in its current form, knowing that this will likely take 10 years or more. All while your children quickly grow up around you.
  3. You take out a renovation loan today and have access to a loan amount that lets you tackle everything on your wishlist right now, enjoy your perfect home with your family and make affordable monthly repayments.

You only raise your family once, and a home improvement loan could help you to do so in a home that best suits your needs.

How do I know if a RenoFi loan is right for my project?

The RenoFi team is standing by to help you better understand how RenoFi Loans work and the projects they are best suited for. Have a question - Chat, Email, Call now...

How Do Home Improvement Loans Work?

Now that you understand the different types of home improvement loans that are available to you, there’s a good chance that you want to see how they work, especially in terms of borrowing based on your home’s future value.

And to help you understand how home improvement loans work (specifically a renovation loan), let’s compare a RenoFi Loan with a standard home equity loan.

Meet the Jenkins.

Their home’s current value is $500,000 and they owe $350,000 on their mortgage, meaning there’s $150,000 in equity.

The renovation project that they want to undertake will cost $250,000 but will increase their property’s value to $750,000.

Borrowing based on 80% LTV, this means they’d be able to take out a home equity loan of $50,000. Whereas, in comparison, a RenoFi Loan could allow them to borrow $250,000.

The Jenkins can borrow $200,000 more by taking out a RenoFi Renovation Home Equity Loan instead of a traditional home equity loan.

jenkins

And this is all because it’s based upon their home’s future value, rather than what it’s worth today.

Their home is going to increase in value, and they’re able to borrow against that, without the need to refinance their first mortgage that they locked into on a great interest rate.

before and after

The way you finance your renovation can have a huge impact; be sure to take the time to understand your options and go with the one that’s best suited to you and your project.

Can Renovations Increase Your Home’s Value?

Yes, they absolutely can.

And the fact that renovation work can increase your home’s value is one of the reasons why some types of home improvement loans allow you to borrow based on your property’s after renovation value rather than its current value.

The average homeowner gets about a 75% ROI on renovations. However, this is dependent on your neighborhood, which parts of your home you are renovating, and other factors.

But not all renovations bring about the same return on investment, with some delivering a much greater return than others.

The renovations with the best ROI are usually:

  • Kitchen & bathroom remodels
  • Upgrading the curb appeal
  • Finishing the basement

But don’t forget that doing a renovation isn’t just about increasing your home’s value.

After all, the reason you first started looking into ways to finance your wishlist is probably that you’re ready to turn your house into your forever home and want to undertake all of these projects at once and enjoy a home that meets the needs of you and your family.

The fact that you can add value just makes it easier to borrow and gives you the reassurance that you’ll be able to get back most of what you spent on the work if you ever decide to sell up and move on.

Are Home Improvement Loans Tax Deductible?

One of the questions that is most commonly asked about home improvement loans is whether or not the interest is tax-deductible.

Maybe you’ve heard that, in some cases, you can deduct the interest paid on home equity loans on your tax return?

Perhaps you’re also aware that the Tax Cuts and Jobs Act of 2017 reduced the number of tax breaks for homeowners.

So then, what does this mean for you?

Typically, home improvement loan interest is tax-deductible when:

  • Your loan is secured against your home.
  • This is used to carry out substantial improvements that add value, prolongs its useful life, or adapt it for a new use.
  • The loan amount doesn’t go above $750k for a married couple or $375k for a single borrower.

(This information is designed to provide general information regarding the subject matter covered. It is not intended to serve as tax, legal, or other financial advice related to individual situations. Because each individual’s tax, legal, and financial situation is different, you should seek advice based on your particular circumstances from your own accountant, attorney, and/or other advisor regarding your specific situation.)

When looking at the options above, this means that interest is tax-deductible on RenoFi Loans, construction loans (including Fannie Mae HomeStyle Loans and FHA 203(k) Loans), home equity loans and lines of credit and cash-out refinances.

You cannot deduct the interest paid on a personal loan or credit card that is used to pay for home improvements.

Why Choose A RenoFi Loan?

Hopefully, you now understand your options when it comes to taking out a home improvement loan, as well as the pros and cons of the different types.

But for most homeowners who are considering the financing options for their home improvement project, the best option is going to be a RenoFi Home Equity Loan.

To recap; this type of loan:

  • Offers loan amounts from $25k to $500k
  • Has the same low rates as traditional home equity loans & HELOCs
  • A term of up to 20 years
  • Gives you the ability to borrow up to 90% of your home’s After Renovation Value
  • Gives you access to the full loan amount at closing
  • Has the same low fees as traditional home equity loans & HELOCs
  • Doesn’t require you to refinance your first mortgage

Why not try our loan calculator to see how much you could borrow, schedule a call or chat online with one of our team who are on hand to help you to understand your options and answer any questions that you might have.

How do I know if a RenoFi loan is right for my project?

The RenoFi team is standing by to help you better understand how RenoFi Loans work and the projects they are best suited for. Have a question - Chat, Email, Call now...