What Are Home Improvement Loans and How Do They Work?

Many home renovation daydreams are swiftly crushed by the associated price tag. It's often manageable for homeowners to pay cash for small-scale repairs, but larger upgrades can add up to thousands of dollars and require other funding.

That’s where home improvement loans come in. The term is something of a misnomer, being that it includes different types of loans or lines of credit that you can use to fund all kinds of home repairs, from structural damage to room remodels and even energy-efficiency or accessibility upgrades.

Find out what home improvement loans are, how they work and which type of home improvement financing best suits your renovation project.

Table of contents

• How do home improvement loans work?
• How do I choose the right home improvement loan?
• Summary of Money’s guide to home improvement loans

How do home improvement loans work?

You can choose from unsecured and secured loan options to pay for home improvement projects. These options have different interest rates and collateral requirements, so you'll need to decide which is best for you.

• Secured loans require collateral, which is a financial asset or property that a borrower pledges to a lender as security for a loan. Your car, home, investments and savings are all considered assets. You must put property up as collateral to qualify for secured home improvement loans like cash-out refinancing, FHA and home equity loans.

• Unsecured loans don't require collateral. Personal loans and credit cards fall in this category, and lenders usually charge significantly higher annual percentage rates (APRs) to offset the higher risk of unsecured loans.

Best for rehabilitating damaged properties: FHA 203(k) rehab loan

An FHA 203(k) Rehab Loan is a type of mortgage loan offered by the Federal Housing Administration that's designed for properties that require significant repairs. It allows borrowers to finance both the purchase and refinance of a property, as well as the cost of its renovation or repair.

Borrowers can purchase a fixer-upper and finance its repairs under a single loan instead of applying for a mortgage and renovation loan separately. Homeowners who wish to renovate a current property can also apply for this loan by refinancing their existing mortgage. With FHA-backing, homeowners benefit from lower interest rates. Lenders also have protection against risk even before the appraiser properly assesses the home's value.

The FHA offers two types of 203(k) loans: a standard 203(k) loan for major repairs and limited 203(k) loan meant for minor renovations.

The total purchase and renovation price must not exceed FHA loan limits, which vary by state (you can use the FHA's tool to find out the limits for your area). All repairs and upgrades must be FHA-approved, and lenders must also abide by a specific appraisal process and work with pre-qualified consultants and contractors.

Make sure you work with an FHA-approved lender that has extensive experience with this loan type specifically. You can use the U.S. Department of Housing and Urban Development's (HUD) Lender List Search tool to find a lender near you.

Qualification criteria:

• Your property must be residential only, at least one year old and include one-to four-units, including condominiums and townhomes
• Borrowers can’t build a home from scratch but can demolish or raze a structure as long as the property preserves its foundation.

Minimum credit score required: 500 or higher

Average rates: Rates vary, but average rates range from 4.5% to 7.5%

Pros

• For older, damaged properties
• Low 3.5% down payment
• Fixed or adjustable rates
• Variable or adjustable low interest rates
• Federally insured
• No income limit
• Renovations will increase the home's value quickly
• Can be combined with an FHA Title 1 loan
• Allows eligible cosigner

Cons

• Requires collateral
• 3.5% down payment is not available for credit scores lower than 500
• FHA approval needed for the entire process
• Has origination & closing fees
• Repairs must be for your primary residence
• There are maximum loan limits that vary by state
• Investment and commercial properties are not eligible
• Luxury upgrades like swimming pools are not eligible
• No DIY allowed

Best for homeowners with poor credit and low equity: FHA Title 1 property improvement loan

An FHA Title 1 property improvement loan helps homeowners finance renovations even if they don’t meet the credit and equity requirements of private lenders. The FHA insures the mortgage, which means that the government pays up to 90% of the loan if the borrower can't repay it.

Loans with an FHA guarantee protect lenders against potential loss and ease qualification requirements for the borrower. Instead of looking solely at traditional metrics, lenders also evaluate your income and verify your employment. The maximum loan amount is $60,000 for a multifamily home ($25,000 for a single family), and loan terms are capped at 20 years.

While you must use a Title 1 loan for home upgrades, FHA restrictions allow for a bit more flexibility. As long as you use the funds for permanent repairs that improve the use and livability of the property, you won't break the FHA's rules. You can even use the money to purchase certain appliances or renovate non-residential structures, mobile and manufactured homes. Unlike a 203(k) Rehab Loan, you may DIY or hire contractors at your discretion.

Qualification criteria:

• You must own the property title or have a long-term lease
• You must be able to make monthly payments
• Your debt-to-income ratio must not exceed 43%
• You need to have occupied the house for a minimum of 90 days

Minimum credit score required: none set by the HUD, but this may vary by lenders

Average rates: Rates vary by location

Pros

• Government-backed
• No home equity required
• Low, fixed interest rates
• Fixed monthly payments
• No prepayment penalties
• No collateral for loans under $7,500
• Can be combined with 203(k) loan
• Allows eligible cosigner

Cons

• Requires FHA-approved lender
• Requires FHA-approved appraisal
• Loan amounts over $7,500 require collateral
• Maximum loan limits
• Origination and closing fees
• Repairs must be pre-approved
• Excludes temporary repairs or luxury upgrades, like swimming pools

Best for when mortgage rates are low: cash-out refinance

A cash-out refinance pays off your first mortgage and replaces it with a new, larger loan that results in a lump-sum cash amount for discretionary use. The new loan may have different terms, such as a different interest rate or length. Cash-out refinances can have fixed or adjustable rates.

Lenders generally allow borrowers to access around 80% of the home’s value, meaning they must leave about 20% equity in the home. For example, say your home is worth $300,000, and you still owe $200,000 on your current mortgage. You have $100,000 in equity, but most lenders won’t let you pocket that full $100,000 in your cash-out refinance.

Eighty percent of your home’s value, in this case, is $240,000. That’s the maximum loan-to-value ratio (LTV) for your new loan. When you refinance for that $240,000, you’ll get to keep the $40,000 as cash.

Since cash-out refinancing involves taking out a new mortgage, this option makes the most sense if the new loan offers better interest rates and terms and if you’re financing improvements that increase your home’s value and equity. Money's mortgage refinance calculator can help crunch the numbers for you. If a cash-out refinance is a net positive, start researching and comparing loan rates from our best mortgage refinance companies.

Minimum credit score required: 620 or higher

Average rates: Rates vary, but average rates range from 5% to 8%

Pros

• Fixed-interest rates and monthly payments
• Lump-sum cash amount
• Unrestricted use
• Can finance the renovation of a rental property

Cons

• Increases total amount of debt
• Requires underwriting and appraisal
• Has originating and closing costs
• Requires a healthy DTI ratio
• Requires a good credit score
• Requires enough equity

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Best for homeowners with stable income and high equity: home equity loans

Home equity loans are installment loans repaid over five- to 30-year terms via fixed monthly payments. You’re essentially taking out a second mortgage, borrowing against your home equity to secure funding. This money may be spent on costly expenses like home improvements, college, debt consolidation or long-term medical care.

Home equity loans are risky. While they can fund important life expenses, they have high interest compared to first mortgages. The best home equity loans favor homeowners who can comfortably afford long-term debt and have built enough equity. Using them to get out of economic hardship is generally not advisable, as failure to repay puts your home at risk.

A home equity loan amount cannot exceed 85% of your home equity, so it’s a good idea to have a budget in place for your renovation before considering this option. You should also consider how much you’ll pay in closing costs, origination and appraisal fees.

Minimum credit score required: 680 or higher

Average rates: Rates vary, but average rates are 8.66% as of March 2024

Pros

• Fixed rates and monthly payments
• Lower rates than personal loans and credit cards
• Lump-sum cash amount
• Unrestricted use
• Interest may be tax-deductible

Cons

• Foreclosure risk
• Requires enough equity
• Requires a stable, reliable income
• Upfront application and appraisal costs
• Origination fees
• Requires strong credit score

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Best for homeowners with high equity who need flexibility: home equity line of credit (HELOC)

A home equity line of credit, commonly called a HELOC, borrows against home equity, just like a home equity loan. The difference is that a HELOC awards a revolving credit line backed by your home equity instead of a lump sum payment.

A revolving credit line awards you more flexibility than a lump sum, especially if the renovations don’t have a set price tag. You can withdraw money as needed up to a certain amount, but it’s common for lenders to set minimums and charge withdrawal fees.

HELOC interest rates will depend on your credit history, loan-to-value ratio and loan amount. Cosigners are one way to get a better rate but won’t have any ownership rights to the property.

Home equity lines of credit have an initial “draw period” (10 years in most cases), during which you can withdraw money. Repayment plans within this period vary. Some lenders allow you to start paying the principal plus interest in monthly installments, or interest first and principal at the end.

What matters most is that you must be ready to repay any outstanding debt in full after the draw period expires, whether by refinancing or some other means. Failure to do so risks foreclosure.

A HELOC’s flexibility can work against you if you use it irresponsibly and borrow beyond your means. Before settling on a HELOC, explore and compare every loan option and gather information from trustworthy sources. The Federal Reserve Board's guide to HELOCs provides a great starting point.

Minimum credit score required: 680 or higher

Average rates: Rates vary, but the average rate is currently 8.98% as of March 2024

Pros

• APR rates are lower than most credit cards
• Revolving line of credit to be used at your discretion
• Offers flexibility on a renovation budget
• Lenders may waive closing costs
• Interest may be tax-deductible

Cons

• Foreclosure risk
• Requires enough equity
• Requires strong credit
• Higher rates than first mortgages
• Variable interest rates
• Added appraisal and closing costs
• Lenders may freeze or reduce credit line
• Rental properties do not qualify

Best unsecured option for good to excellent credit scores: personal loan

Personal loans can be convenient for homeowners with good to excellent credit scores who need fast financing and don’t want to put their homes up as collateral.

The best personal loans are available from several private lenders and credit unions. The application process can be much faster than the other financial options on this list, especially if you work with an online lender.

Many personal loan servicers also guarantee no prepayment penalties and direct funding to your bank account by the next business day. Monthly repayment plans tend to be significantly shorter than other financing options, with most options ranging between one to five years.

Lenders heavily weigh your creditworthiness during the application process and offer the best rates if you have excellent credit. Loan providers look at your credit history and use your FICO or VantageScore to determine their risk.

If your credit score needs work, you can find out how to repair your credit or look into Money's list of best credit repair companies. Keep in mind that even the best personal loan interest rates may still be higher than for secured loan options since the lack of collateral or government insurance poses a higher risk for the lender.

Minimum credit score required: 580 to 660 or higher

Average interest rates: Rates vary, but average rates range from 15% to 36% as of March 2024

Pros

• No foreclosure risk
• No home equity requirements
• Lump-sum cash amount for discretionary use
• Fast funding
• Fixed or variable interest rates
• Lenders may waive origination fees

Cons

• Higher loan rates
• Requires good to excellent credit
• Short repayment term
• No federal loan benefits or protections
• Interests are not tax-deductible

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Best for affordable, small-scale projects: credit cards

Consider a credit card for minimal upgrades you can afford to pay in full but would prefer to finance over a few months, such as a paint job or a new appliance.

Many credit cards offer an low to 0% introductory APR period of 12 to 18 months, meaning you won’t pay any interest on the outstanding balance for a full year. You can also take advantage of any cashback rewards for home improvement-related purchases.

Best practices include never charging more than you can afford and keeping your credit utilization ratio below 30%. Be aware that credit card APRs tend to be very high, and they're currently surging to all-time average highs. Outstanding debt can quickly snowball and plummet your creditworthiness, so for large-scale home renovations or long-term projects, it’s best to consider other loan options.

Minimum credit score: Varies per credit card type and company

Average interest rate: Rates vary, but the average rate is close to 23% as of March 2024

Pros

• No collateral needed
• 0% APR introductory period
• Unrestricted use
• You can use the credit line as needed
• Possible cashback rewards

Cons

• Very high APR rates
• High debt can become unmanageable
• Raises credit utilization ratio
• Best for simple, affordable repairs
• Interests are not tax-deductible

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How do I choose the right home improvement loan?

To choose the best home improvement loan, you'll want to examine your financial situation. That means looking at your credit report, credit score, credit history, debt-to-income ratio, mortgage equity and income. Determine the cost of your home improvement project, research your funding options and compare lenders to find the lowest rate.

Are you willing to put your home as collateral, or do you prefer an unsecured personal loan? Do you qualify for any federal loan programs? Our guide on how to get a home improvement loan can help you get started on your loan application.

Home Improvement Loans FAQ

How long are home improvement loans?

The term length of your home improvement loan depends on the type of loan you choose. Personal loan terms range from 12 to 60 months. Loans backed by your mortgage tend to have longer repayment periods. A home equity loan or home equity line of credit may last up to 20 years, and FHA caps its property improvement options at 20 years.

Where to get a home improvement loan?

You can get home improvement loans from your mortgage servicer, personal loan providers, or FHA-approved lenders. If you already own a home, consult with your bank and compare their offers with types of loans to get the best terms and lowest rates.

Can you use a home improvement loan for anything?

Personal loans meant for home improvement can still be used for other expenses, should the need arise. The same applies to funds acquired through a cash-out refinance, home equity line of credit, or home equity loan. Home improvement loans acquired through federal loan programs are stricter. After meeting eligibility requirements, pre-qualified contractors must make all repairs, and funds must be used for home improvements, as defined and approved by the lender and FHA.

Should I take out a loan for home improvement?

Everyone could pay for home improvements in cash in an ideal world, but repairs are often so expensive that a loan is the only option. If repairs are necessary and you plan on living there for many years, then yes, consider taking out a home improvement loan.

Summary of Money’s guide to home improvement loans

Home improvement loans are financing options for homeowners who want to upgrade their homes and can afford long term debt. Homeowners with enough equity may be able to fund expensive repairs with a cash-out refinance, home equity loan or home equity line of credit.

Qualifying borrowers who do not meet the credit or equity requirements should consider more affordable FHA loans tailored for home renovations, like a 203(k) Rehab Loan or Title I Property Improvement loan.

Personal loans charge higher interest rates but may offer a more flexible alternative if you have good to excellent credit. An advantage is that there are no collateral requirements and no use restrictions.

Make sure that the home improvement loan and renovation will pay for itself in the long run, increasing the value of your home and contributing to your overall quality of life.

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