Pros and cons of using a personal loan for a home renovation

If you’re looking for the best way to pay for your renovation, you might be confused about your options.

In fact, we’ll take a guess that you’ve been told you should look into getting a ‘home improvement loan,’ you’ve spent time reading all about them on Google, and now you have even less clarity on the best way to pay for your project.

You see, the definition of a home improvement loan is pretty vague, and that’s where the problem starts.

Home improvement loans are often just rebranded unsecured personal loans or credit cards

They have high interest rates, and when you factor in their shorter terms of 5 to 10 years, the monthly payments will almost certainly end up being crazily high.

You probably shouldn’t use personal loans to pay for your home renovation project, but they are acceptable in the following instances:

• You have great credit.
• Your cash flow can cover your monthly payment.
• You have a robust home emergency fund.
• You don’t have equity in your home.
• You don’t want to use your home or car as collateral.

<h2>Downsides of Personal Loans

Before applying for a personal loan, understand how much you need to borrow and estimate your monthly payments. If you can’t afford the loan while staying within your regular budget, we recommend finding an alternative. Keep in mind the following downsides, as well.

1. High Interest Rates

Personal loans are unsecured, which means they come with a much higher interest rate than secured loans (such as home equity loans) that use your property as collateral.

And we’re not just talking a little bit higher.

You’ll usually end up paying a rate of somewhere between 8% and 15% on a personal loan, or even higher on a credit card.

You see, the more risk your borrowing poses to a lender, the more interest you’ll pay. They want a bigger reward in return for taking a risk on you. Since there is no collateral, that’s the highest risk lending there is. If you can’t repay your personal loan, expect a major drop in your credit score.

Many personal loans also come with an origination fee of between 1% and 6%, adding costs you might not have anticipated.

A higher interest rate results in higher monthly payments, meaning that your home improvement project financed with a personal loan will cost more.

In comparison, a RenoFi home equity loanhas rates nearly as low as what you would get with a first mortgage.

2. Shorter Payback Period

The repayment term on a personal loan will most likely be between 5 and ten years.

In comparison, a home renovation loan commonly offers a payback period of between 20 and 30 years.

A shorter repayment term means higher monthly payments, with excessive late fees if you miss a payment. You should only use a personal loan when you know you can afford the repayment. If you have inconsistent income, you risk setting yourself up for a debt trap.

Combine a higher interest rate with a shorter payback period and it becomes pretty clear that personal loans aren’t the best way to finance a renovation for homeowners seeking a low monthly payment.

3. Much Less Borrowing Power

Renovations can be expensive, and it’s not uncommon to need to borrow $100,000 or more to undertake your full wishlist.

But while there may appear to be options that will let you borrow this amount on a personal loan, the reality is that most only go from $25k to $35k.

In fact, very few borrowers will actually qualify for a personal loan that goes anywhere close to $100k, with lending criteria based strictly on your income and credit score.

This means that it’s unlikely that you’ll be able to borrow what you need to complete the renovations you want to carry out unless you finance your project in a different way.

Now, on the other hand, the average RenoFi loan is $175,000, with loan amounts from $20k to $500k and the ability to borrow up to 90% of your property’s after renovation value.

To put it simply, if you tackle a renovation project, choose a financing option that doesn’t limit you from getting everything you want.

And this is rarely a personal loan or credit card.

4. Interest Isn’t Tax-Deductible

If you use a home equity loan to pay for your renovation, and the renovation classifies as one of the following conditions:

• A substantial improvement
• Adds value
• Prolongs the home’s useful life
• Adapts a home for a new use

Then, the interest paid is tax-deductible, so long as your loan amount doesn’t exeed:

• $750k for married couples
• $375 for a single borrower

But the interest paid on a personal loan is not tax-deductible.

If you’re taking out a sizable loan to pay for an addition (or, for example, financing an ADU), these tax deductions can add up, meaning it’s even more important to consider your options.

So Why Do People Use Personal Loans to Pay for Renovations?

While we don’t recommend personal loans as the right way to pay for home improvements for most homeowners, there are times when they’re the best-fit solution.

Here are some of the more common reasons why they’re used:

If You Only Need to Borrow a Small Amount

A personal loan may be the best option if you only need to borrow a small amount of money to fund your home improvement project (either because you’re paying most of it with cash or aren’t carrying out extensive work).

For example, the minimum you can borrow with a RenoFi loan is $20k.

If you only need a few thousand dollars, you won’t need to be too concerned about lower borrowing power or a shorter payback period. Plus, the money will likely be handled to you in a lump sum, so you can get it all at once to start working on your project.

They're Fast & Simple to Secure

Getting approved for a personal loan and getting the cash is quick, as well as being pretty simple to secure, even if you have a low credit score. There is an easy application process since there are NO home inspections or appraisals. You may just need to show proof of income and employment.

You won’t need to provide collateral, as they’re unsecured, and it’s not unusual for the whole process to take just a few days. Comparatively, funds from a HELOC or home equity loan can take several weeks.

Since there’s no collateral, the lender can’t take your possessions if you don’t make the payments.

<h3>You Can Budget Fixed Monthly Payments

Personal loans typically come with fixed APR (annual percentage rate) and monthly payments over a set number of years. Plan accordingly, and you should be able to stick to your budget easier each month.

We also encourage you to learn more about RenoFi’s fixed rate home equity loan optionif you are looking for fixed payments.

There's a Misconception That Personal Loans are the Only Option if You Have No Equity in Your Home

It’s not uncommon for homeowners who have recently purchased their home to assume that a personal loan is the only way to finance a home improvement project because they have little to no equity in the property.

And while this may make it difficult to borrow sufficiently with a home equity loan, home equity line of credit or a cash-out refinance, options are available.

Home renovation loans, for example, allow you to borrow based on the future value of your home after work has been completed, significantly increasing the amount you can borrow and helping to make your wishlist a reality.

Choose a RenoFi loan, which can increase borrowing power by more than 12x while ensuring that the lowest possible interest rate is secured.

Just because you haven’t built up equity, it doesn’t mean you have to scale back your plans.

Justin Goldman, Co-Founder & CEO of RenoFi addresses this problem, highlighting that:

“The two most popular existing financial products used to finance home renovations - Cash-Out Refinance or a Home Equity Loan - are not designed for renovations, and while they can work well for long-term homeowners (those who’ve been in their homes 10+ years), they don’t serve recent homebuyers who haven’t yet built up equity.”

Just look at how even the most basic renovations are out of reach for years to come when relying on equity as your only lever:

The good news is that alternatives do exist, even if you haven’t built up equity in your home.

Alternatives to Personal Loans to Finance Home Renovations

Most of the time, you shouldn’t use a costly personal loan to pay for your remodel.

But what are your other options and how do they stack up?

Home Renovation Loans

Given that a home renovation loan lets you borrow based on the after renovation value of your property, they’re the most attractive option for many projects.

You see, renovations typically mean that your house will increase in value, and a good average to work on here is that for every $100k spent, homeowners will see an increase in their property’s value by $75k.

And this method of financing allows you to access this additional value upfront to help you to pay for the project.

But there is more than one type of home renovation loan…

A RenoFi Loan

Take out a RenoFi loan and you’ll benefit from borrowing power based on your home’s after renovation value, without needing to refinance your first mortgage.

To put it simply, this is the perfect way to borrow the most money at the lowest possible rate.

These loans also have low fees, a flexible term of up to 20 years, and the same low interest rates as any home equity loan.

Check out this illustration to help you understand how a RenoFi loan can help you to borrow the money you need to finance your entire renovation wishlist:

These loans were created specifically to solve a problem that homeowners were facing, and offer a purpose-built product to help finance renovations as cost-effectively as possible.

Cash-Out Refinance

If you have built up equity in your home, a cash-out refinance will allow you to refinance your first mortgage and release some of this.

The funds that are released can then be used to finance your renovation.

But, unlike a home renovation loan, the amount you can borrow is based upon your home’s current value, typically maxed out at 80%.

With a cash-out refinance, your borrowing power will be significantly less than alternatives. You may also need to change your mortgage provider, potentially losing any low-interest rate that you’re locked into.

Add to this the fact that you’ll also be paying closing costs and potentially a higher rate than other financing options and it’s pretty easy to see why most homeowners shouldn’t use a cash-out refinance for renovations.

Cash

Paying for home improvements with cash means you don’t face the costs of interest or fees.

And while this sounds ideal, don’t forget that it can take years to save up sufficient funds to cover the cost of the projects that you want to undertake.

During this time, you could have been enjoying the improvements to your home and making affordable repayments every month rather than making do and dreaming of one day having your forever home complete.

There’s no denying that cash is the cheapest way to finance any renovation project, big or small, but the time it takes to save up enough funds usually means it’s not a viable option.

Speak to RenoFi

By now, hopefully, you’ve realized the pros and cons of using personal loans.

A RenoFi loan stands out against other financing options. It can help you borrow the money you need for your project without needing to refinance your current mortgage while benefiting from lower fees and choosing your own term of between 10 and 20 years.

Chat with us today and we’ll help you finance your home improvements!

Related Articles:

• What Are Home Improvement Loans?
• What Are Construction Loans?