Making improvements is typically one of the main priorities of homeowners. Outdated kitchens, ugly bathrooms, and the horrendous color that the previous owners decided to use in the bedroom are headaches that few want to live with for long. The problem is that actually making these improvements can be financially cumbersome, leaving many to live in a home with a dishwasher older than their children.
Luckily there are home improvement loans specifically for these high-priced projects. While these loans operate like most lines of credit, there are specific pros and cons of home improvement loans that any prospective remodeler should take into consideration.
The first major argument for a home improvement loan is that there are several types of loans intended to meet any size and price of a specific project. Updated lighting is much less expensive than remodeling a kitchen and home improvement loans are engineered to fit the scope of the individual project.
A secured home improvement loan, for instance, uses your house as collateral, allowing the homeowner to borrow more money at a lower rate. While an unsecured home improvement loan does not use any collateral and typically has lower amounts available to borrow. A secured home loan would be best if you need to borrow a large lump sum of money for a big project, while an unsecured home improvement loan works best for smaller, more manageable fixes like updating a few appliances or a large painting project.
Home improvement loans typically have a longer payback period than other types of loans (10 to 15 years is pretty typical) and also most have a lower interest rate than other types of credit. Home improvement loans also have the added advantage of being a fixed-rate loan, locked in at the time of origination.
If you plan on using money over a longer period of time, a home equity line of credit (HELOC) would be suitable. A HELOC is essentially a credit card with an astronomically high limit (the average is $58,000). Once used, you make monthly payments on your balance and, also like a credit card, you can theoretically determine how much you pay back and when. Many people take out a HELOC for emergency funds if any financial emergencies should arrive.
The main justification for taking out a home improvement loan is that, applied to the right project at the right price, it will pay for itself. Since you’re using the money to raise the value of your biggest asset, you will see that money back in the final value of your home.
Taking out a home improvement loan comes with risks that many borrowers are familiar with. Default on a loan and your credit can tank, affecting your ability to borrow money in the future.
But there’s another risk to a home improvement loan that doesn't come with other lines of credit. A secured home loan, however beneficial it is towards funding larger projects at a lower interest rate, is using your home’s equity to back the loan. Since you’re using your home as collateral, should you default, your credit won’t only take a fatal hit, but the bank could take your home too.
The main drawback of a HELOC is that the interest rate is tied to the prime rate (the rate lenders provide their most credit-worthy customers) making repayment amounts highly susceptible to market conditions. Although the rate for a HELOC starts pretty low, borrowers assume the risk that a dip in the market can dramatically increase their repayment amount. Although should you default on your HELOC, the bank does not have a claim on your home.
The loan’s ability to increase the value of your home is also largely dependent upon factors outside of your control. If you pump several thousand dollars into a home improvement project but the real estate market takes a hit, you’ll have a wonderful remodeling project with little financial reward. Also, for specialized or large-scale projects, you’ll most likely hire a contractor and finding the right one is the difference between an elegant addition to your home and a poorly executed money pit.
The tax benefits to a home improvement loan also aren’t as attractive as one might assume. Since the tax deductions are determined by a percentage and not dollar-for-dollar, the payout come tax time might not be as high as you think. Also, the IRS has some specific rules regarding whether or not a home improvement loan would qualify in the first place.
A home improvement loan is a terrific way to capitalize on your equity to improve the quality and value of your property, but before signing on the dotted line, consider the pros and cons and whether or not they apply to your goals.