How Do Home Improvement Loans Work?

How Do Home Improvement Loans Work? article image.

A home improvement loan works by providing the money you need to maintain, repair or improve your home. You can choose from different types of funding for your project, so compare your options carefully to learn the pros and cons of each.

What Is a Home Improvement Loan?

A home improvement loan isn't a specific type of loan. Rather, it describes how you're going to use the funds. You could take out a home improvement loan to repair damage after a natural disaster, upgrade your plumbing or build an addition—just to name a few of the many possible projects.

You can use either secured or unsecured loans for home improvements. A secured loan, such as a home equity loan, home equity line of credit (HELOC) or cash-out refinance, requires collateral. In these cases, your home serves as collateral for the money you borrow, and the lender may be able to foreclose on your home if you can't repay the money.

Unsecured loans don't require collateral and include personal loans and credit cards. While you don't have to put your assets at risk to take out an unsecured loan, they may be harder to qualify for or offer less favorable terms.

Where to Get a Home Improvement Loan

Choosing how to finance your home improvement project can depend on the type of work you want to do, your project's timeline and your creditworthiness.

For example, if you need to borrow $5,000 and have good credit, you might want to consider a credit card that has an introductory 0% annual percentage rate (APR) on purchases. Some of the best 0% APR cards have a 15- to 21-month introductory period, during which your purchases won't accrue interest. If you can pay off your balance before the introductory period ends, you may be able to finance your home improvement project for free.

However, a secured loan or unsecured personal loan might have a higher loan limit than a new credit card. The interest rate may also be much lower than a credit card, although interest starts to accrue right away.

If you need a loan quickly, don't want to use your home as collateral or don't have much equity, an unsecured personal loan could be best. But if you're up for a more intricate application process, you are comfortable using your home as collateral, and you've established enough equity to qualify, a secured loan may offer a lower interest rate.

Additionally, you might get a tax deduction for the interest you pay on a home equity loan, HELOC or cash-out refinance if you use the money to substantially improve (rather than do basic repairs or maintenance) your home. To qualify, the IRS says your project must add value to your home, increase your home's useful life or adapt your home for a new use.

What Credit Score Is Needed for a Home Improvement Loan?

Whether you're applying for a credit card, secured loan or unsecured loan, your credit scores, income, debt-to-income ratio and the equity in your home (for secured loans) can all factor into whether you're approved and if you receive favorable terms.

Each creditor and loan type may have its own credit score requirements, but there are some general guidelines. For example, you may need a FICO® Score of at least 660 to get approved for a mortgage-backed loan. However, a 680 credit score or better may increase your chances, and having a score above 700 could make it easier to qualify and receive good terms.

Unsecured loans, including personal loans and credit cards, tend to require higher credit scores because you're not offering collateral to the creditor. You can sometimes get approved with a low score, but if you do, you might not get a high enough credit limit or loan amount to finance your project. Or, you might wind up with such a high interest rate that it isn't worth borrowing the money unless your project is a necessity.

Compare Your Options to Find the Best Rates

No matter which route you're considering, comparing options from multiple creditors can help you find the lowest rates and best terms. With Experian CreditMatchTM, you can quickly compare customized credit card and personal loan offers based on your unique credit profile. You may even be able to get prequalified for a card or loan with a soft inquiry, which won't hurt your credit scores.