Pros and cons of using a personal loan for a home renovation

When you’re looking for the best way to pay for your renovation, it can be overwhelming. There are several options out there, and they all have their benefits and their pitfalls, which carry different weight for every homeowner and their unique situation. 

If we had to guess, you’ve probably been told that a ‘home improvement loan’ is a good idea. But your research has likely left you even more confused on whether or not you should use one to pay for your project.And that’s because the definition of a home improvement loan is pretty vague. Essentially, these loans are often just rebranded unsecured personal loans used for home improvements.This guide is designed to give you the clarity you need on what these loans are really all about. We’ll get you the answers to important questions like should I take out a personal loan? Are personal loans smart for home improvements? And we’ll cover all the personal loan pros and cons to help you make the best decision for you.

Pros and Cons of Using a Personal Loan for Home Improvements

You can use personal loans to buy a house, consolidate debt, cover a large expense like a wedding or medical bill — and of course, you can use a personal loan for home improvements. But should you? 

Compared to some of the alternatives out there, home improvement personal loans will have high interest rates and shorter terms of 5 to 10 years, which drive monthly payments up drastically. But there are some 

Most homeowners have better options than a personal loan for their home improvement goals, but many don’t know what these are and why they’re more suitable. To help you see the differences more clearly, here are the top personal loan pros and cons.

Home improvement loans are often just rebranded unsecured personal loans or credit cards

They have high interest rates, and when you factor in their shorter terms of 5 to 10 years, the monthly payments will almost certainly end up being crazily high.

You probably shouldn’t use personal loans to pay for your home renovation project, but they are acceptable in the following instances:

• You have great credit.
• Your cash flow can cover your monthly payment.
• You have a robust home emergency fund.
• You don’t have equity in your home.
• You don’t want to use your home or car as collateral.

<h2>Downsides of Personal Loans

Personal home improvement loans certainly won’t be for everyone. Considering its higher rates and fees, along with its minimal borrowing power, using a personal loan for a home renovation can be limiting and cause financial strain down the road.

Here’s a little more about those downsides of personal loans for home improvement projects:

1. High Interest Rates
   Personal loans are unsecured, which means they come with a much higher interest rate than secured loans (such as home equity loans) that use your property as collateral.
   
   And we’re talking much higher. You’ll usually end up paying a rate of somewhere between 8% and 15% on a personal loan, or even higher on a credit card.
   
   And this is because the more risk your borrowing poses to a lender, the more interest you’ll pay. They want a bigger reward in return for taking a risk on you. Since there is no collateral, personal loans are some of the highest risk lending there is. If you can’t repay your personal loan, expect a major drop in your credit score.
   
   Many personal loans also come with an origination fee of between 1% and 6%, adding costs you might not have anticipated.
   
   A higher interest rate results in higher monthly payments, meaning that your home improvement project financed with a personal loan will cost more.
   
   In comparison, a RenoFi home equity loan has rates nearly as low as what you would get with a first mortgage. We also partner with credit unions which can make those rates even lower.
2. Shorter Payback Period
   
   The repayment term on a personal loan will most likely be between 5 to 10 years. In comparison, a home equity loan commonly offers a payback period of between 20 and 30 years, while a HELOC has a delayed repayment window before you even have to start making principal payments and then 10 to 20 years once you do.
   
   A shorter repayment term means higher monthly payments with excessive late fees if you miss a payment. You should only use a personal loan for home improvement purposes when you know you can afford the repayment. If you have inconsistent income, you risk setting yourself up for a debt trap.
   
   Combine a higher interest rate with a shorter payback period and it becomes pretty clear that personal loans aren’t the best way to finance a renovation for homeowners seeking a low monthly payment.
3. Much Less Borrowing Power
   
   Renovations can be expensive — it’s not uncommon to need to borrow $100,000 or more to tackle your entire wishlist.
   
   But while you may have seen personal loan options that will let you borrow this amount, the reality is that most only go from $25k to $35k. And if they do go higher, very few borrowers will actually qualify for a personal loan that goes anywhere close to $100k, with lending criteria based strictly on your income and credit score.
   
   This means that if you’re looking to do a mid to large-scale renovation project, it’s unlikely that you’ll be able to borrow what you need to complete all the improvements you want to carry out unless you finance your project in a different way.
   
   If you want an option that truly boosts your borrowing power, the average RenoFi loan is $175,000 — with loan amounts ranging from $20k to $500k and the ability to borrow up to 90% of your property’s after renovation value.
   
   To put it simply, if you tackle a renovation project, choose a financing option that doesn’t limit you from getting everything you want. And this is rarely a personal loan or credit card.

4. Interest Isn’t Tax-Deductible

If you use a home equity loan to pay for your home improvements, your interest is tax deductible if the renovation classifies as one of the following conditions:

• A substantial improvement
• Adds value
• Prolongs the home’s useful life
• Adapts a home for a new use

Considering your loan amount doesn’t exceed:

• $750k for married couples
• $375 for a single borrower

BUT the interest paid on a personal loan is not tax-deductible.

If you’re taking out a sizable loan to pay for an addition (or financing an ADU for example), these tax deductions can add up, meaning it’s even more important to consider your options when elevating your finances. When using personal loans, your home improvement investment doesn’t give you anything to look forward to come tax time. 

The Upsides of Personal Loans for Home Improvements

While we don’t recommend personal loans for home improvement projects to most homeowners, there are times when they’re the best-fit solution. 

Here are some examples of when the upsides to a personal home improvement loans come in handy: 

1. If You Only Need to Borrow a Small Amount
   
   A personal loan may be the best option if you only need to borrow a small amount of money to fund your home improvement project. Maybe that’s because you’re either paying most of it with cash or aren’t carrying out extensive work.
   
   Alternatives will have higher minimums. For example, the minimum you can borrow with a RenoFi loan is $20k.

If you only need a few thousand dollars, you won’t need to be too concerned about lower borrowing power or a shorter payback period. Plus, the money will likely be handed to you in a lump sum, so you can get it all at once to start working on your project.

2. They’re Fast & Simple to Secure

Getting approved for a personal loan and accessing the cash happens quickly, in addition to being pretty simple to secure — even if you have a low credit score. The application process is pretty easy since there are NO home inspections or appraisals. You may just need to show proof of income and employment.

Since they’re unsecured, you won’t need to provide collateral, so it’s not unusual for the whole process to take just a few days. Comparatively, funds from a HELOC or home equity loan can take several weeks.

And since there’s no collateral, the lender can’t take your possessions if you don’t make the payments.

3. You Can Budget Fixed Monthly Payments

Personal loans typically come with fixed APR (annual percentage rate) and monthly payments over a set number of years. If you plan accordingly, you should be able to stick to your budget easily each month.

But if fixed payments are a big selling point for you, we also encourage you to learn more about RenoFi’s fixed rate home equity loan option. The fixed monthly payments with these loans will be a lot lower. 

Choosing the wrong financing for your home improvement project can lead to overspending or not getting everything on your wishlist. Every loan out there will make sense in certain financial situations and needs, so it’s important to have all the information possible to determine which loan option makes the most sense for your renovation project. 

There’s a Misconception That Personal Loans are the Only Option if You Have No Equity in Your Home

It’s not uncommon for homeowners who have recently purchased their home to assume that a personal loan is the only way to finance a home improvement project because they have little to no equity in the property.

And while this may make it difficult to borrow sufficiently with a home equity loan, home equity line of credit or a cash-out refinance, options are available.

Home renovation loans, for example, allow you to borrow based on the future value of your home after work has been completed, significantly increasing the amount you can borrow and helping to make your wishlist a reality.

Choose a RenoFi loan, which can increase borrowing power by more than 12x while ensuring that the lowest possible interest rate is secured.

Just because you haven’t built up equity, it doesn’t mean you have to scale back your plans.

Justin Goldman, Co-Founder & CEO of RenoFi addresses this problem, highlighting that:

“The two most popular existing financial products used to finance home renovations - Cash-Out Refinance or a Home Equity Loan - are not designed for renovations, and while they can work well for long-term homeowners (those who’ve been in their homes 10+ years), they don’t serve recent homebuyers who haven’t yet built up equity.”

Just look at how even the most basic renovations are out of reach for years to come when relying on equity as your only lever:

The good news is that alternatives do exist, even if you haven’t built up equity in your home.

How a Personal Loan Works for Home Improvement Projects

When you use a personal loan for home improvements, you don’t have to secure it with your home. In fact, most lenders won’t request any information about your home unlike most of the alternative loan options. Instead, they determine your loan amount and your rate based on your financial credentials, including your credit score, income, and debt-to-income ratio.

Once you apply, getting a personal loan for your home renovation happens pretty quickly. You’ll likely be approved and have access to your funds within days versus weeks with a home equity loan or HELOC. At the same time, repayment will happen quicker as well. You’ll have about 5 to 10 years to repay your loan before your credit score takes a major hit, which means your monthly payments will be higher.

Your monthly payments will also be higher because your interest rate will be as well. Since home improvement personal loans are unsecured, they’re more risky to lenders. So in order to protect themselves, they have to make the investment worth it — by jacking up your rates. The best rates for borrowers will require a credit score of 690+. But even with bad credit, you can likely get approved.

We recommend getting estimates from 3-4 potential contractors to better understand your overall project costs based on your key wish list items. Talk to them about material costs and alternatives, as well as any discounts they may be able to get you. Then, calculate your monthly payments and compare them to your project budget to make sure you know how much you can afford.

Assessing the scope and cost of your home improvement project

Before applying for a personal loan, you should understand how much you need to borrow and estimate your monthly payments. If you can’t afford the loan while staying within your regular budget, we recommend finding an alternative.

Here are some ways to help you get started:

• Research & ask questions.
  There is no such thing as a stupid question when planning a renovation. Reach out to other homeowners who have completed similar projects, talk to your financial advisor, and make use of helpful guides and calculators online. Research what permits your project will need and talk to contractors about materials and your timeline. If it’s flexible, consider doing your project in the off season where things will be cheaper and less busy. The more you know, the better.
• Budget during the design phase.
  Plan early! Try to finalize all materials and furniture choices during design so you have everything you need once construction begins. Some products may take weeks to ship, so getting a head start can help you avoid delays, while preventing changing market conditions from skewing your plans along the way.
• Factor in labor costs.
  Labor will make up about one-third of your total project costs (materials will make up the rest). These costs will be impacted by the time of year, your area, contractor availability, and how many / if they use subcontractors for specific phases. Make sure you consider these costs in your overall budget.
• Get multiple estimates.
  We recommend obtaining at least 3-4 estimates from professionals to better understand your project costs. While one contractor may be cheaper than another, they may not have the materials or skills you’re looking for. And if one contractor is way more expensive than the others, then you know something isn’t right. The more comparables you have, the better. 
• Factor in ROI
  Understanding the return on your investment is another important aspect of budgeting and scoping your project. While some wishlist items may be important to you, they may not put any more money back in your pocket when all is said and done. Reversely, some more expensive improvements could significantly improve your home’s value, giving you more back than what you put in. If your loan can help you cover it, don’t necessarily be intimidated by the numbers now if they can pay off down the road.
• Consider all your financing options.
  Do your research on all your options (RenoFi is here to help with that!) Determine what qualities of a loan product are most important to you. Do you need a longer repayment window and lower monthly payments? Are low interest rates important to make your project affordable? How much do you need to borrow and will a personal loan cover your home improvement wish list?
  
  If you need as much borrowing power as possible with the lowest rates, a RenoFi loan is a no-brainer. With a RenoFi Renovation Loan, RenoFi Home Equity Loan, or RenoFi HELOC, you can take advantage of more money and a low, fixed interest rate — without need to refinance or deal with a messy draw period like other construction loans out there. And unlike financing your home improvement list with a personal loan, your monthly payments won’t be incredibly high due to a short repayment period.

Who Should Consider a Personal Loan for Home Renovations

So when should I take out a personal loan? While a home renovation project typically won’t be the best use for this type of financing, they are acceptable in the following situations:

• You have great credit.
• Your cash flow can cover your monthly payment.
• You have a robust home emergency fund.
• You don’t have equity in your home.
• You don’t want to use your home or car as collateral.

If you’re simply looking to tackle a couple of home repairs or minor improvement projects, then a personal loan could still be a good option for you, especially if you need the money quickly. In some cases, such as a broken HVAC or mold infestation, the money can’t wait. Similarly, in a competitive market, you can use a personal loan to buy a house to help you get the funds quickly to compete with other offers and strict deadlines. In other words, personal loans may be a good way to get the funding you need under a ticking clock. 

Alternatives to Personal Loans to Finance Home Renovations

Most of the time, you shouldn’t use a costly personal loan to pay for your remodel.

But what are your other options and how do they stack up?

Home Renovation Loans

Given that a home renovation loan lets you borrow based on the after renovation value of your property, they’re the most attractive option for many projects.

You see, renovations typically mean that your house will increase in value, and a good average to work on here is that for every $100k spent, homeowners will see an increase in their property’s value by $75k.

And this method of financing allows you to access this additional value upfront to help you to pay for the project.

But there is more than one type of home renovation loan…

A RenoFi Loan

Take out a RenoFi loan and you’ll benefit from borrowing power based on your home’s after renovation value, without needing to refinance your first mortgage.

To put it simply, this is the perfect way to borrow the most money at the lowest possible rate.

These loans also have low fees, a flexible term of up to 20 years, and the same low interest rates as any home equity loan.

Check out this illustration to help you understand how a RenoFi loan can help you to borrow the money you need to finance your entire renovation wishlist:

These loans were created specifically to solve a problem that homeowners were facing, and offer a purpose-built product to help finance renovations as cost-effectively as possible.

Cash-Out Refinance

If you have built up equity in your home, a cash-out refinance will allow you to refinance your first mortgage and release some of this.

The funds that are released can then be used to finance your renovation.

But, unlike a home renovation loan, the amount you can borrow is based upon your home’s current value, typically maxed out at 80%.

With a cash-out refinance, your borrowing power will be significantly less than alternatives. You may also need to change your mortgage provider, potentially losing any low-interest rate that you’re locked into.

Add to this the fact that you’ll also be paying closing costs and potentially a higher rate than other financing options and it’s pretty easy to see why most homeowners shouldn’t use a cash-out refinance for renovations.

Cash

Paying for home improvements with cash means you don’t face the costs of interest or fees.

And while this sounds ideal, don’t forget that it can take years to save up sufficient funds to cover the cost of the projects that you want to undertake.

During this time, you could have been enjoying the improvements to your home and making affordable repayments every month rather than making do and dreaming of one day having your forever home complete.

There’s no denying that cash is the cheapest way to finance any renovation project, big or small, but the time it takes to save up enough funds usually means it’s not a viable option.

Speak to RenoFi

By now, hopefully, you’ve realized the pros and cons of using personal loans.

A RenoFi loan stands out against other financing options. It can help you borrow the money you need for your project without needing to refinance your current mortgage while benefiting from lower fees and choosing your own term of between 10 and 20 years.

Chat with us today and we’ll help you finance your home improvements!

Related Articles:

• What Are Home Improvement Loans?
• What Are Construction Loans?