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How Do Home Improvement Loans Work? Step by Step Guide

The only thing better than buying your dream home is finally sprucing it up the way you like. If you are planning to renovate your home, but are worried about the finances, there’s a simple solution. 

Home improvement loans have been designed specifically for remodeling homes and covering all the expenses involved. This covers all the costs of home renovation such as contractor fees, painting, raw materials and even adding floors in some situations.

There are several different types of loans you can choose from while remodeling your home. Which type of loan you should choose will depend on several factors such as your end goal, home equity, and credit history. Here are your options while looking for home improvement loans that give you the greatest value at the lowest cost:

Types of Home Improvement Loans:

  1. Personal loans:

Personal loans are by far the easiest and fastest cash disbursal methods. A personal loan is an unsecured loan, which means you don’t need to mortgage any assets against which to borrow funds. Lenders don’t monitor or care about how the funds are used once they are disbursed. If you skip loan payments or default, you won’t lose any assets, but it will reduce your credit score. 

Personal loans are usually approved instantly with an online application process. It is more efficient than other options like home equity loans, especially during times of financial strain. You also pay back the loan much faster because of the short-term loan tenure. Most personal loans offer tenures no longer than five to seven years. Meanwhile, a home equity loan stretches out for decades.

Once you know what your end goal is and how much the home renovation will cost, it is easy to evaluate your options and get the most value. 

  1. Cash-out refinancing:

Cash-out refinancing refers to changing the terms and conditions of your existing home mortgage to cash out some of your existing home equity. The proceeds can then go towards your home improvement project. 

Cash-out refinancing requires revising a long-term mortgage. This change will have long-term implications for you, so experts recommend that you do so when the market rate is low. You can save as much as 2-5% on your home mortgage by doing so. In the long term, this is a significant amount of money. 

  1. Home Equity Line of Credit or HELOC:

HELOC refers to money you get from your home equity, which is calculated as the value of your home less the cost of your existing loan amount. Since a HELOC is essentially a second loan on your existing home, your house becomes collateral against which the loan amount is disbursed.

A HELOC usually has a draw period of about ten years during which time you can partially or completely use the funds that you have been approved to borrow. One key feature of a HELOC is that you don’t need to repay the principal amount during your draw period. This makes it a sensible option in case you are planning to sell the property in the future. That way, the unpaid principal that remains will be deducted from the value of the home sale. As a result, you won’t have to pay any additional funds out of your pocket. 

However, keep in mind that a HELOC has variable interest rates. If you will be too severely affected by a higher rate, this might not be the best option for you.

  1. Home equity loans:

Home equity loans are very similar to HELOCs but come with a fixed rate of interest. A home equity loan is a good choice if you have a clear picture of how much you will spend on the entire renovation project. In contrast to a HELOC, you receive the loan amount from a home equity loan in a lump sum. You also need to start repayments of both principal and interest immediately. 

Immediate loan repayments might seem like a burden, but it proves to be beneficial in the long run. It means you start rebuilding your home equity immediately. A home equity loan has a low rate of interest since it is a secured loan. This means you get a guaranteed low rate of interest on a loan of 15 to 20 years. 

The key factor before taking a home equity loan is to know how much your project will cost. Experts recommend that you get a quote from your contractor while your lender is underwriting your loan. You can thus understand the feasibility of your borrowing and only take as much as you need instead of overborrowing and overspending. 

Must Read: Personal Loans Are Growing, Is the Right Time to Take This?

  1. Credit cards:

The higher APRs that credit card companies charge to make them ideal for smaller renovation expenses. If you are thinking of buying new furniture or getting one room of the house painted, you can use your credit card itself instead of taking a full loan. You can also use credit cards for surprise expenses like replacing appliances or fixing broken windows or doors. 

If you are applying for a loan in any form, make sure you compare the best personal loan interest rates in the market to find a loan that best suits your needs.

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