Owning a home is an ongoing responsibility and expense. From yardwork and leaky sinks to kitchen remodeling and replacing the roof, there’s always something that needs fixing or upgrading. And the price tag can vary as much as the tasks themselves — from a few bucks all the way up to tens of thousands of dollars.
When the project requires borrowing money to pay for it, two of the most common choices for homeowners are a personal loan or a cash-out refinance.
Key Takeaways:
- A personal loan can be an easy way to pay for improvement projects without refinancing your mortgage. Personal loans can be secured by your home equity, or unsecured, much like a personal loan.
- A cash-out refinance will let you borrow your home equity at a lower interest rate than a personal loan and repay it as part of your mortgage.
- If neither type of loan meets your financial needs, consider alternatives such as home equity loans or HELOCS.
Funding Improvements With a Personal Loan
A personal loan is an unsecured loan that must be paid back with interest over a certain time frame.
Compared with mortgages, personal loans require less documentation. Mortgage lenders typically confirm your identity, credit score and history, debts, and income. What you don’t need, however, is home equity.
Lenders generally respond to an application within a few days. If approved, the lender will tell you how much you can borrow based on your financial situation, with the typical range from $5,000 to $45,000.
A personal loan usually will have a fixed interest rate and a repayment term of two to five years. The interest rate will be influenced by your credit score and market forces. Since it’s an unsecured loan, expect a higher interest rate than you would get on a mortgage.
For example, if a homeowner takes out a personal loan for $10,000 at a 9% interest rate with a five-year repayment schedule, the monthly payment would be $208, and they would pay $2,455 in interest over the life of the loan.
Can you take out a personal loan for home improvements? The answer is yes.
“Personal loans can be easier to get since they don’t require a certain amount of equity in a property, but they need to be paid back on time and in full to avoid bankruptcy because they lack collateral,” says Martin Orefice, a real estate broker and CEO of Rent To Own Labs, based in Orlando, Florida.
Home improvement loans
Though many lenders offer home improvement loans, these are essentially personal loans marketed to homeowners.
The key difference is that with a personal loan, you’re free to use the loan proceeds in any way you wish. With a home improvement loan, the lender will require that you use the money for home improvements. Agreeing to those restrictions may help you qualify for a lower interest rate or other beneficial loan terms.
Examples of home improvements that can be funded with a personal loan
Some common home improvements to finance with a personal loan include:
- Replacing windows.
- Buying new appliances.
- Fixing your rain gutters.
- Painting your home.
- Upgrading your cabinets.
- Upgrading lighting fixtures.
- Replacing flooring.
Funding Improvements With a Cash-Out Refinance
Taking a cash-out refinance for home improvements is more complicated than getting a personal loan. It requires you to apply for a new, larger mortgage based on your home’s current value, and you use that loan to repay your current mortgage. The leftover cash can be used for anything you like.
The advantage of refinancing your mortgage in this way is you can borrow more money, depending on how much equity you have, and repay it over a longer time at a lower interest rate.
Applying for a cash-out refinance is getting a new mortgage, so you’ll need to provide your lender with full documentation of your income, assets, and debts. You also will need sufficient equity in your home, usually at least 20%. Other common requirements include a debt-to-income ratio of less than 50%, a credit score of at least 580, and proof of employment and income.
You need to pay refinance closing costs on your new mortgage, which run about $5,000 on average.
Refinancing for home improvements resets the term of your mortgage, and could extend how many years you need to make payments. If your original mortgage had a 30-year term and you’ve been paying it and building equity for years, then refinancing to a new 30-year loan will start you over.
Examples of home improvements that can be funded with a refinance
Using a cash-out refinance lets you borrow a larger amount for a longer period of time and at a lower interest rate. That makes it a better choice for larger, more expensive improvements such as:
- Building an addition.
- Installing a pool.
- Adding solar panels to your home.
- Rebuilding a retaining wall.
- Remodeling a bathroom or kitchen.
- Replacing a roof.
- Finishing a basement.
- Installing an HVAC system.
Pros and Cons of Using a Personal Loan for Home Improvements
Here are some advantages to taking out a personal loan to pay for home improvements:
- No collateral. If you’re unable to repay your personal loan, your credit score will take a hit and you’ll likely get slammed with late payment fees and a lawsuit. But you won’t risk losing your home, car, or other major assets.
- Easy application process. Most of today’s lenders offer same-day approval and quick loan disbursement. By filling out an online application, you can quickly find out how much you could borrow and what your interest rate will be, among other important details.
- Fixed repayment plan. Personal loans typically come with a fixed interest rate and a specific repayment term. That means that you can determine exactly how much you’ll have to pay each month, and for how long.
- Fewer fees. You have to pay closing costs to refinance your mortgage, which can run thousands of dollars. While you may need to pay some fees with a personal loan, shopping around and asking lenders to reduce or waive fees can keep such fees to a minimum.
And here are some disadvantages:
- Higher interest rates. Personal loans are unsecured and typically have higher interest rates than a home equity line of credit or home equity loan.
- Higher penalties and fees for delinquent payments. Many personal loans will charge penalties if you’re late on a payment and you may wind up facing other stiff penalties.
- Requires good credit. To be approved for a personal loan, you should have a decent credit score. The higher your score, the better the rate you’ll receive, though the opposite can be true if you have a score that’s on the lower end.
- The interest isn’t tax deductible. While the interest payments you make on loans are often tax deductible, interest on most personal loans is not. The only ways you can deduct an unsecured loan’s interest payments are if you use it for business expenses, qualified higher education expenses, and taxable investments.
Pros and Cons of Using a Cash-Out Refinance for Home Improvements
Here are some reasons homeowners might want to do a home improvement refinance and get cash out to pay for the project:
- Large loan amounts. If you’re planning on making more expensive fixes or improvements, a cash-out refinance will allow you to borrow larger sums of money than you can get with a personal loan.
- The interest is deductible. You can deduct mortgage interest from your income taxes, which you can’t do with a personal loan. Also, if you keep track of the home improvements you make to your home, you may be able to get a tax benefit in the year you sell your home.
- Improvements could add equity. Refinancing to make improvements can make your home more attractive to potential buyers, which affects your home’s value and equity.
- You may have leftover cash if you underspend. If you finish your improvements and come in under budget, you might have some extra cash that you can put toward another use.
And here are some drawbacks:
- Your home is collateral. Since your home is used as collateral for a cash-out refinance, you could lose your home to foreclosure if you fail to make your payments.
- Strict requirements. Though personal loans can be relatively easy to get, a cash-out refinance loan requires a lot from potential borrowers.
- It takes longer to close. It can take between 30 and 45 days to close on a cash-out refinance, so you’ll need to plan ahead if you want to use this method of funding home improvements.
- Longer repayment period. Though this can be seen as a benefit, it could also become an issue for some borrowers. That’s because restarting your mortgage’s repayment period means you’ll be making interest payments longer, effectively increasing your expenses over time.
Alternatives to a Personal Loan or Cash-Out Refinance for Home Improvements
Before deciding between a personal loan or a cash-out refinance, consider some alternative ways to pay for home improvement projects.
Home equity loans
A home equity loan lets you take borrow a lump sum of your home equity. Unlike a cash-out refinance, a home equity loan doesn’t replace your existing mortgage. Instead, it’s a new loan on top of your mortgage. The drawback of this is that you’ll have two monthly payments, and the terms of a home equity loan may not be as good as the terms of a mortgage. However, if you have a great interest rate on your current mortgage, you might not want to give it up with a cash-out refinance.
Home equity lines of credit
Home equity lines of credit turn your equity into a pool of credit that you can borrow from as needed. That makes HELOCs ideal for situations where you don’t know precisely how much you’ll need to finish a project or will need consistent access to funds. HELOCs typically have a variable interest rate, which means your payments can rise and fall as rates do. The repayment terms may also not be as long as they are for cash-out refinancing.
Title I property improvement loans
Title I property improvement loans are specialized loans insured by the U.S. Department of Housing and Urban Development. This insurance helps lenders offer easier approvals and larger loan amounts, even to borrowers with less-than-perfect credit. To be eligible, the improvements must “substantially protect or improve the basic livability or utility of the property.”
Energy-efficient mortgages
Energy-efficient mortgages are another government program designed to help borrowers improve their homes. These loans focus specifically on improvements that increase the sustainability of a property. For example, you could use an EEM to buy new windows or install a new heating and cooling system for your home, but not to build an addition to your home. Those restrictions mean they’re not great for every situation, but that focus lets them offer easier approvals and larger loans.
Credit cards
Credit cards generally aren’t a great choice for long-term financing due to their low limits and high interest rates. However, many cards offer an introductory period where no interest is charged. That offers homebuyers a chance to pay no interest if they can pay off the balance before it ends. Interest-free periods from 12 to 20 months aren’t unusual. If you only need a small amount of financing and can pay it off within a year or so, a no-interest credit card could let you finance the home improvement for free.
How To Choose Between a Personal Loan and Cash-Out Refinance
So, is it better to refinance or get a personal loan to make home improvements? When it comes to choosing between a personal loan or refinance, you need to consider your financial situation and the scope of your home improvement project.
If you have decent credit and only need a few thousand dollars, a personal loan could be the right fit.
However, if you’ve been in your house for a long time and built up enough equity, you could take out a much larger amount of money and do more expensive work around the house by going with a cash-out refinance.
FAQ: Personal Loan vs. Cash-Out Refinance for Home Improvements
Here are answers to common questions about using a personal loan vs. a cash-out refinance for home improvements.
Some of the top improvements for adding equity include:
— Appliance upgrades.
— Kitchen remodels.
— Bathroom remodels.
— Adding a deck.
— Landscaping and other improvements to curb appeal.
— Energy efficient improvements.
To land a better rate on a personal loan, use these tips:
— Improve your credit score.
— Pay off existing debts to lower your DTI ratio.
— Increase your income to lower your DTI ratio.
— Apply for a secured loan.
— Be able to show a stable employment history.
— Consider applying with a co-signer.
— Shop around and compare lenders.
Generally, the more equity you have, the better your credit score, and the lower your DTI ratio, the more you’ll be able to borrow. For example, imagine you have a $500,000 home with a $350,000 mortgage and no other debts. Your lender allows a maximum LTV of 80% for a cash-out refinance, so you can cash out $70,000, which would leave you with a new mortgage balance of $420,000 and 20% equity in the home. At an 8% interest rate and a term of 30 years, your loan would cost $3,082 per month.
The Bottom Line on Paying For Home Improvements
Every home needs improvements or repairs eventually. Fortunately, there are several options for borrowing the cash to pay for them. How much you need and the cost of repaying the loan are essential factors in deciding if a personal loan or a refinance mortgage is the right way to go. Understanding how each works and the pros and cons of both options equips you to make a decision that’s right for you.
T.J. Porter contributed to the reporting of this article.
