When financing a home renovation or remodel, homeowners often consider two popular options: a home equity loan and a home improvement loan. Both types of loans offer advantages, but understanding the differences can help you make an informed choice and achieve your home improvement goals.

Comparing the Home Improvement and Home Equity Loan Side by Side

home equity loan vs home improvement

While home equity loans and home improvement financing provide access to funds for making improvements, they work differently and cater to various financial situations and needs for funding a home improvement project.

Here’s a breakdown of each to help you determine which loan might be right for you.

What is a Home Improvement Loan?

A home improvement loan is often referred to as unsecured personal loan that doesn’t require using your home as collateral. Instead, lenders assess your creditworthiness and financial stability to determine eligibility and loan terms. As a result, interest rates on unsecured home improvement loans tend to be higher than on home equity loans, especially for those with less-than-perfect credit. However, if these personal loans are unsecured, there is no risk of foreclosure if you can’t make payments.

The unsecured home improvement loans are a better choice for homeowners who either don’t have much home equity or prefer not to use their home as collateral. These personal home improvement loans work well for smaller projects, like updating appliances, landscaping, or refreshing a bathroom. Additionally, many of the top home improvement loans often come with shorter repayment terms than home equity loans, which means monthly payments can be higher, but the loan is paid off sooner.

However, there are many second mortgages for home improvements and many homeowners still take out home equity loans to renovate their house or investment property.

What is a Home Equity Loan?

A home equity loan allows homeowners to borrow against the equity they have built up in their home. Essentially, the home serves as collateral for the loan, allowing homeowners to receive a lump sum of money that can be used for large expenses, including home improvements. The home equity loan amount you can borrow typically depends on the appraised value of your home and how much you still owe on your mortgage, with most lenders offering up to 80 to 90% of the home’s equity.

How does a home equity loan work for home improvements?  The home equity loan usually come with a fixed interest rate, meaning monthly payments stay the same over the loan term. They are ideal for homeowners with substantial equity who need a large amount for significant projects, like a new roof or an addition. However, if you default on the home equity loan, there’s a risk of losing your home, as it serves as collateral. Ask yourself this question, “Is this the right time t take out an equity loan to finance a home improvement project?”

Which Loan is Best for You?

Choosing between a home equity loan and a home improvement loan largely depends on your financial goals, available equity, and project scope. If you have significant equity and want lower interest rates with predictable payments, a home equity loan may be the better option, especially for extensive projects. However, if you lack equity or prefer to avoid using your home as collateral, a home improvement loan provides flexibility without the risk of losing your property.

7 Best Home Improvement Loans

home improvement project

Home improvement projects can significantly enhance a home’s value and transform living spaces to better suit your needs and tastes.

However, financing these renovations can be challenging.

While paying cash is ideal, many homeowners rely on loans to cover the cost of their projects. With numerous loan options available, it can be hard to decide which one best suits your situation.

Below, we’ll explore the seven most popular home improvement loans, detailing their benefits and what they bring to the table for homeowners.

1. Home Equity Loan

Home equity loans are among the most popular options for financing home improvements. Think of this loan as unlocking a hidden treasure chest in your home—equity you’ve built over time that can be used to fund renovations. This type of second mortgage loan allows homeowners to borrow a lump sum of money by tapping into their home’s equity, usually up to 80%–85% of the home’s appraised value, minus any remaining mortgage balance.

With fixed interest rates and predictable monthly payments, home equity loans offer stability, making budgeting easier. This equity loan option is ideal for homeowners who have built significant equity and want to finance large projects with a known cost. However, it’s important to note that the home is collateral, so failure to repay the home equity loan could put your property at risk.

Key Benefits:

  • Fixed interest rates
  • Large loan amounts available
  • Predictable monthly payments

2. Home Equity Line of Credit (HELOC)

If a home equity loan is a treasure chest, a HELOC is more like a reusable credit card attached to your home’s equity. A HELOC allows homeowners to draw funds and pay for home improvement projects as needed during a set period, typically 5–10 years, known as the “draw period.” During this time, borrowers make interest-only payments, keeping monthly costs low. However, once the draw period ends, the repayment period begins, and homeowners must start paying back both principal and interest.

The home equity line of credit comes with a variable interest rate, which means payments may fluctuate. This interest only HELOC is best suited for homeowners planning ongoing or phased projects, as it provides flexibility in borrowing. However, as with home equity loans, HELOCs use your home as collateral, meaning nonpayment could result in foreclosure.

Key Benefits:

  • Flexible borrowing during the draw period
  • Interest-only payments initially
  • Ideal for phased or multiple projects

3. Personal Loan

What if you need a loan without tapping into your home’s equity? A home improvement personal loan might be your answer. Think of a personal loan as a quick fix, a straightforward option for smaller projects or when you need funds fast. Unlike home equity loans and HELOCs, personal loans are unsecured, meaning you don’t risk losing your home if you default. However, because there’s no collateral, lenders usually charge higher interest rates on home improvement personal loans.

Personal loans come with fixed rates and terms, offering predictable monthly payments. The personal loan is ideal for smaller home improvement projects or homeowners without much equity. However, keep in mind that personal loan interest rates vary widely based on credit scores, so borrowers with lower scores may face higher costs.

Key Benefits with the Personal Loan:

  • No collateral required
  • Quick approval process
  • Fixed monthly payments

4. FHA 203(k) Loan

The FHA 203(k) loan is a unique product that combines a mortgage with a home improvement loan, making it a one-stop-shop for homebuyers purchasing a fixer-upper. If you’ve ever looked at a house and thought, “If only it had a new kitchen and updated floors!”, this loan may be for you. The FHA 203(k) loan, backed by the Federal Housing Administration, allows buyers to finance both the purchase and renovation costs of a property.

This equity loan is particularly appealing to buyers who want to buy and improve a home but lack substantial cash for renovations. However, the FHA 203(k) loan comes with specific restrictions on the types of home improvements allowed and requires borrowers to work with an FHA-approved contractor.

Key Benefits:

  • Combines purchase and renovation into one home renovation loan
  • Government-backed, potentially lower credit requirements
  • Ideal for buyers of fixer-uppers

5. Cash-Out Refinance

With a cash-out refinance, homeowners can replace their existing mortgage with a new one that has a higher loan amount, receiving the difference in cash. It’s a bit like upgrading to a new and better toolkit—your mortgage stays the same in purpose, but now you’ve got extra funds for improvements. Since the new loan replaces your existing mortgage, this can be a good option if you qualify for a lower interest rate, as it may reduce monthly payments while providing cash for renovations. There is also a conventional rehab loan offered from Fannie Mae or Freddie Mac.

Cash-out refinancing is best for homeowners who have considerable equity in their home and could benefit from refinancing their mortgage. However, it does extend the mortgage term, so it’s essential to consider how these home improvement loans might affect long-term financial goals.

Key Benefits of Cash Out Refinance:

  • Potential to lower interest rates
  • Access to large loan amounts
  • Consolidates mortgage and renovation financing

6. Credit Card

For smaller or immediate expenses, a credit card can be a convenient choice. Imagine it as a versatile tool you always have on hand, but with a word of caution: credit cards come with high-interest rates, and carrying a large balance can be costly. Many credit cards offer rewards programs or introductory 0% APR periods, which can help make small renovations more affordable if you pay off the balance quickly.

Credit cards are ideal for minor home improvement projects that can be paid off within a few months. However, using credit cards for extensive home improvements isn’t advisable unless you have a low-interest or 0% APR offer.

Key Benefits:

  • Quick and accessible
  • Potential for rewards or cash back
  • Great for minor or short-term projects

7. Title I Property Improvement Loan

Backed by the Federal Housing Administration, the Title I Property Improvement Loan is designed specifically for home improvements and requires no home equity for approval. It’s like a ladder that reaches places other loans can’t, helping homeowners who lack equity or need financing for smaller projects. With loan limits up to $25,000 for single-family homes, the Title I loan is accessible for those without much equity.

This loan requires fixed monthly payments and can be used for various home improvements, excluding luxury items like pools. Additionally, the Title I loan has a capped interest rate, which may offer savings compared to other high-interest loan options.

Key Benefits:

  • No home equity required
  • Fixed monthly payments
  • Government-backed, accessible to those with less equity

Choosing the Right Home Equity Improvement Loan

So, which loan is right for you? Are you a first-time buyer eyeing a fixer-upper? If so, an FHA 203(k) loan could be perfect for combining purchase and renovation costs. Do you need flexibility for ongoing improvements? A HELOC might be your best bet. Every loan has distinct features tailored to different needs, credit histories, and financial situations, making it vital to carefully evaluate your priorities.

Remember, choosing the best home improvement loan involves not only finding the right interest rate but also assessing terms, repayment flexibility, and how each home equity loan and personal loan aligns with your overall financial plan.

Securing the right home improvement loan can make a significant difference in how smoothly your renovation project unfolds. From home equity loans to credit cards, to personal loans, each financing option serves a unique purpose. Like tools in a toolbox, some loans are better suited for large structural projects, while others are ideal for quick, small fixes. As with any financial decision, understanding the benefits and limitations of each option will help you make the best choice.

Home improvements can turn a house into your dream home, increase property value, and enhance daily living. Choosing the best financing option is a big step toward making that dream a reality. So, whether it’s a new roof, remodeled kitchen, or an added bedroom, there’s a home improvement loan to support your vision and budget.

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