How to Choose Between a Home Improvement Loan and a Home Equity Loan
Renovating your home to make it more healthy and functional isn’t cheap. Even minor kitchen and bathroom projects can cost thousands, and if you’re looking to do some major renovations, you’re likely looking at a five-figure price tag. That’s where a home improvement loan or a home equity loan will come in handy.
Taking out one of these loans can help you make the improvements you need without spending everything upfront. While the intentions behind getting one of these two loans may be the same, the loans themselves are not. Here are the key differences between a home improvement loan and a home equity loan.
What is a Home Improvement Loan?
A home improvement loan is an unsecured personal loan that you can take out without providing collateral. Basically, you would be borrowing money from a lender that isn’t tied to your home or car or other values, so you won’t be at risk of losing the physical property.
Like most other loans, home improvement loans are paid back in installments or regular monthly payments, depending on the loan’s size. Also, like most other loans, the amount you qualify for is based on your credit history and your annual income. Typically, these loans range anywhere from $1,000-$50,000, depending on the project’s size, the term of the loan, and your ability to repay it.
We strongly recommend getting a home improvement loan over putting it on a credit card.
These loans also usually have a lower APR than a credit card and a fixed rate as opposed to the variable rates you’ll get with a credit card.
Many lenders offer easy-to-follow online applications for home improvement loans, and the approval process goes pretty quickly. Sometimes, you’re even able to get your cash on the next business day!
What is a Home Equity Loan?
Home equity loans use the equity of your home (the difference between your home’s value and your mortgage balance) as collateral. While your interest rates will be more competitive than with a home improvement loan, home equity lenders place a second lien on your home if you use it as collateral. This means that if you fail to make payments, you’re putting your home at risk.
How much money you’re eligible for is determined by the combined loan-to-value (CLTV) ratio. This ratio is the total of both loans (your mortgage and your home equity loan) added together and then divided into the value of your appraisal.
Let’s assume that your bank offers a maximum CLTV ratio of 80%. If your home is worth $500,000 and you owe $300,000 on your mortgage, you will qualify for a home equity loan of $100,000 ($500,000 x 0.80) = $400,000 – $300,000 = $100,000).
Here’s a calculator to help you better understand this ratio.
Home equity loans are not good for small projects. Most lenders won’t give you one for anything less than $35,000, so think about what you need to be done and how much it’s going to cost before you get this loan.
Spot the Differences
To recap, here are the key differences between a home improvement loan and a home equity loan:
| Home Improvement Loan | Home Equity Loan |
| Unsecured personal loan | Secured loan |
| No collateral needed | Collateral = the equity of your home |
| Quick approval turnaround | Longer approval turnaround |
| Loans range from $1,000-$50,000 | Loans are usually at least $35,000 |
| Higher interest rate | Lower interest rate |
| Determined by credit and ability to repay | Determined by CLTV ratio, credit, and ability to repay |
| Shorter payback periods | Longer payback periods |
Which loan is best for you? That depends largely on what kind of project(s) you’re looking to undertake and your ability to pay it back.
