Home Equity Loan vs. Home Improvement Loan: Which is Best?

Compare Financing Options for Your Home Improvement Goals

Most homeowners have a running list of changes or upgrades they’d like to make. Home remodels can not only make your home more personalized, but they can boost your home’s value.

But home improvement projects, whether cosmetic or structural, can be expensive. If you don’t have much in savings, you can finance the project with a home equity loan or home improvement loan. But how do you know which is the right choice? We’ll help you learn the key differences so you can choose the best loan for your needs.

At a Glance: Home Equity and Home Improvement Loans

Before we dive into the specifics of each loan type, here’s a quick breakdown of the core distinctions between these loan options so you can decide the best way to fund your home repairs or renovations:

What Is a Home Equity Loan?

A home equity loan is a type of second mortgage. You borrow against your home’s equity, which is the current value of your home minus the amount you still owe on your existing mortgage, and get a lump sum of money for home renovations.

Home equity loans use your home as collateral—which means you risk foreclosure if you don’t repay the loan. These loans typically come with longer repayment terms and lower interest rates, since the loan is secured by your home.

Pros and Cons of Home Equity Loans

Potential benefits of home equity loans include:

• Lower interest rates
• Can be tax-deductible if used for home improvements
• Larger borrowing potential
• Predictable monthly payments

Drawbacks of home equity loans to consider include:

• Risk of foreclosure
• Closing costs and other fees required
• Less equity left in your home
• Longer repayment period

A home equity loan can be a smart choice if you want predictable payments and lower rates for a larger project. But you need to be comfortable with the risk involved when using your home as collateral.

What Is a Home Improvement Loan?

A home improvement loan is essentially an unsecured personal loan that you can use to fund home renovations. It doesn’t rely on your home’s value as collateral. Instead, approval is based on your credit score and debt-to-income ratio (DTI).

These loans typically have fixed interest rates, no origination fees, and shorter repayment terms, which makes them ideal for smaller or mid-sized projects you may want to complete.

Pros and Cons of Home Improvement Loans

Home improvement loans can offer these benefits:

• Quick access to a lump sum of cash for your home improvements
• No home equity required
• Home is not used as collateral
• Flexible loan amounts

Some potential disadvantages of home improvement loans are:

• Higher interest rates
• Lower borrowing limits
• Higher monthly payments due to shorter repayment periods
• Stricter credit requirements

A home improvement loan offers flexibility without tapping into your home’s equity, which is ideal for those who don’t have much built up yet. But keep in mind, higher rates could strain your budget.

How To Choose Between Home Equity and Home Improvement Loans

If you’ve weighed the pros and cons but still aren’t sure whether a home improvement or home equity loan is better, we’re here to help. From the amount of equity you have to the cost of your home renovations, here are some scenarios to help you decide:

Home Equity Loan Alternatives

Home equity loans and home improvement loans can be useful tools for financing upgrades in your home, but they’re not the only choices worth considering. Common alternatives include a home equity line of credit (HELOC) and a cash out refinance.

Home Equity Line of Credit (HELOC)

With a HELOC, you borrow money against the value of your home. During the draw period, which is usually 5 to 10 years, you can borrow money up to a certain limit determined by your equity. HELOCs function similarly to credit cards. You’ll make interest payments at a variable rate during the draw period. Then, you’ll enter a longer repayment period when you’re required to pay principal and interest.

HELOCs are a good option if you’re not sure exactly how much you’ll need for your home improvements. But, just like home equity loans, your home is used as collateral when you take out a HELOC.

Cash Out Refinance

If you have significant home equity, a cash out refinance could be a good way to fund home improvements. Cash out refinances replace your current mortgage with a new, bigger loan. They can have lower interest rates but also carry a potentially longer repayment period and a likely increase in your monthly mortgage payment.

Final Thoughts: Financing Your Home Improvements

Your budget, timeline, and comfort with risk will all determine whether a home equity loan or home improvement loan is a better option. If you’d like to consider more options, we at Freedom Mortgage can help you achieve your home improvement dreams with a HELOC or cash out refinance.

See which might be better for your home improvement needs and get prequalified today to make your home what you’ve always dreamed of.