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What is a Home Improvement Loan?
Homeowners can apply for home improvement loans for a variety of reasons, including remodeling, updating or making repairs to their home. Loans can be issued for anything as simple as a roof repair, an update to an energy-efficient furnace or a new addition. Repayment for this type of loan can be made in many different ways. A homeowner can take an unsecured loan or use the equity in the home as collateral. A homeowner can also take a first mortgage loan or a subordinate loan. Each scenario is unique and will require careful analysis of the type of financing that may be best suited for the situation.
If You Have Little or No Equity in the Home
- For minor repairs or updates: Your only choice would be an unsecured loan. Since the repairs or updates to the property are minor, the value of the property would not increase enough for a lender to use the home as collateral. Since the loan is unsecured, interest will be charged at a higher rate than if secured by the property; but the loan will not come with the higher closing costs associated with mortgage loans.
- For major repairs, updates or remodeling: You may have a couple of options. If your current first mortgage rate is low, you may wish to opt for a second mortgage to keep your low interest rate intact. If your current mortgage rate is higher than the current market rate, you may wish to refinance under a renovation loan or “as repaired” value cash-out refinance to take advantage of the lower rates. In either case, the lender will require itemized repair and remodel plans to base the property appraisal on the “after-improved value” of the home. These loans will have lower interest rates than an unsecured loan, but will have more closing costs involved. Your options will be dependent on the results of the “improved value” because lenders will have a maximum loan to value limit.
If You Have a Large Amount of Equity in the Home
- For minor repairs or updates: The amount of the loan is probably small enough to justify getting an unsecured loan or line of credit. When the loan amount is small, it’s better to use a loan with low or no closing costs. The unsecured loan would have a higher interest rate than the home equity line of credit (HELOC) and the credit line can be reused if needed.
- For major repairs, updates or remodeling: If your equity in the home is adequate, the lender would be willing to loan you the cash needed in a number of ways. You would be eligible for a HELOC, installment second mortgage and a cash-out refinance. Ultimately, your particular financial situation or desired outcome would determine which product is preferable. If you want to preserve your current interest rate, you may opt for the HELOC or second mortgage installment loan. These options will have higher interest rates on the junior liens, but will have substantially less closing costs. If you’re looking for cash flow or if you can lower the interest rate currently being paid on your first mortgage, you may want to opt for the cash-out refinance.
Everyone’s financial situation and needs are unique, so consult a loan officer about which option best suits your needs.