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If you’re hoping to make some home improvements but need help with the costs, a home equity loan, home equity line of credit (HELOC), or personal loan could all be a good path forward. All three can be used to finance home improvement and remodel projects, but each comes with its own pros and cons.
The right one will depend on your personal situation, finances, and goals. If you’re not sure which one to use for your home repairs, this guide can help.
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Comparing personal loans, home equity loans, and HELOCs for home improvements
There are three main loan options you have when financing home improvements. First, there’s a personal loan (sometimes called a home improvement loan, when used in this context). These are loans that can be used for any purpose and are usually a little loose on credit score requirements. Most are unsecured and don’t require collateral, such as an asset like a car or home.
If you own your home, you also have two other options: home equity loans and HELOCs. A home equity loan is a type of second mortgage loan that lets you borrow against your home’s equity. It offers a lump-sum payment up front, and you’ll pay off the balance month over month, as you’ve done with your first mortgage.
HELOCs, like home equity loans, also let you tap your home equity—only in a slightly different way. Instead of receiving your funds in one single payment, you’ll be able to draw from the HELOC as needed, much like a credit card. You won’t need to repay your balance until sometime down the road—usually about 10 years.
To get a clear idea of how these three financing options differ, check out the below chart:
|Personal Loan||Home Equity Loan||HELOC|
|Loan Type||Unsecured loan||Secured loan||Secured line of credit|
|Collateral||None||Your home||Your home|
|Payout||Lump sum||Lump sum||Withdraw as needed|
|Loan Amounts||Up to $100,000*||Home value minus mortgage balance (up to lender’s limits)||Home value minus mortgage balance (up to lender’s limits|
|Repayment||Monthly payment (typically up to five years)||Monthly payment (typically over a five- to 30-year term)||Interest-only payments during draw period (usually 10 years) then repayment begins (usually 10 to 20 years)|
|Time to Funding||Under a week||Multiple weeks/months||Multiple weeks/months|
|Tax Deductible?||No||If you use the funds to improve the value of the home||If you use the funds to improve the value of the home|
|See Options||Best Home Improvement Loans||Best Home Equity Loans||Best HELOCs|
*Depends on the lender you work with.
Deciding whether to use a personal loan or home equity for home improvements
Unsecured personal loans and home equity products all have their benefits, but they’re not right for everyone. To see which option is best for your current situation, check out the following scenarios:
Use a personal loan when:
- You don’t own your home or haven’t owned it very long. If you don’t own your home (or just very recently bought it), then you haven’t built up equity yet. Unless you put up a hefty down payment, you probably won’t have a substantial amount of equity until a few years down the road.
- You don’t want to put up collateral. Personal loans are usually unsecured, meaning you don’t have to offer an asset or piece of property as collateral. Home equity loans and HELOCs, on the other hand, are secured loans, with your house offered as the collateral. This puts the property at risk should you fail to make your payments.
- You want the money soon. Most personal loans take only a few days to fund, which is great if you’re in need of some quick cash. Home equity products take a lot longer (usually more than a month).
Use a home equity loan when:
- You have built equity in your home. If you’ve owned your home a while or paid down a lot of your mortgage balance, then a home equity loan can be a smart way to pay for home improvements. To qualify for a home equity loan, you’ll usually need a loan-to-value ratio of 80% or lower—meaning your loan balance is only 80% or less than your home’s total value. To calculate your LTV, take your current loan balance and divide it by your home’s value (on your annual property tax bill). Multiply by 100, and that’s your LTV.
- You want a lump sum for a single project. If you need a substantial amount of money all at once, home equity loans can be a wise choice. Unlike HELOCs, these loans give you a lump sum payment as soon as you’re approved.
- You know what you’ll use the money for. Home equity loans can also be helpful if you know exactly what you’re using the funds for and have a good handle on how much it will all cost. (You don’t want to take out a larger home equity loan than necessary, as it will mean paying more in long-term loan interest.)
Use a HELOC when:
- You have built equity in your home. Like home equity loans, your eligibility for a HELOC will depend on how much equity you have in your house. And the more equity you have, the bigger the credit line you can get.
- You can’t make full payments for a bit. If you can’t afford to repay your loan right now, then you might want a HELOC. HELOCs allow you to make very minimal payments (often interest-only ones) during what’s called the “draw” period—the period of time when you can withdraw funds. A draw period is usually 10 years, and then the repayment period begins.
- You’re not sure how much cash you need. If you’re not exactly sure how much your projects will cost or if you just want the option to withdraw money over a longer period of time, then a HELOC can be a good way to go. Unlike the other options, HELOCs don’t come with lump-sum payments. Instead, you can pull from your balance as necessary during your draw period.
- You’re a responsible spender. Because HELOCs function like credit cards, they’re not great for flippant spenders. If you can’t trust yourself to be responsible with an open-ended line of credit, you might want to consider other financing options.
The bottom line
Personal loans, home equity lines of credit, and home equity loans are all good ways to cover the costs of home renovations and improvements. Whichever you choose, make sure it fits your financial situation and be sure to shop around, as rates and loan terms can vary significantly from one lender to the next.
If you want lower interest rates, consider improving your credit score before applying for your loan. The higher your score, the lower the rates for which you’ll qualify (and the more money you’ll save in the long run).
Author: Aly Yale
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