When seeking to renovate their homes, unless they’re paying cash, most homeowners choose between two types of loans: a home improvement loan vs. mortgage loans. While home improvement loans are unsecured loans with shorter payback periods, mortgage loans (also referred to as home equity loans or second mortgages) are secured by the property being improved.
Let’s look at each in greater detail so you can decide which type of loan better meets your needs when you’re ready to remodel or expand your home.
What is a home improvement loan?
A home improvement loan is a broad term used to describe a loan taken out for financing a home improvement project, whether it be adding a swimming pool, putting up a new fence, adding a bedroom, or any other modification that would improve your property.
The most common type of home improvement loan is a personal loan. While personal loans can be used for any purpose, home improvements and debt consolidation are two of the most common uses.
A personal loan is an unsecured debt, meaning it isn’t tied to any kind of collateral, including your home. This is beneficial if you become unable to repay the loan because the lender can’t foreclose on you or take any other collateral you may have put up (although this will damage or ruin your credit for up to seven years).
The amount you can borrow for a home improvement loan is up to the lender. They will typically base that amount on your financial condition, including your bank account balances and credit report. The interest rate you’re charged will be based on your creditworthiness.
What is a mortgage loan?
A mortgage loan (also known as a home equity loan, home equity line of credit (HELOC), or a second mortgage) is a type of secured loan that can be used for home improvements or any other purpose you’d like to use the money for.
Mortgage loans are secured by your property, meaning you are pledging your home as collateral. While there are some inherent advantages to mortgage loans (discussed below), because it is a secured loan, you risk losing your home if you can’t pay it back.
A mortgage loan is usually based on the amount of equity you have in your home and is generally capped at 85% of that amount. For example, if you have $100,000 equity in your home, the maximum amount you could borrow would be $85,000. The lender has the final say in how much you can borrow, which is typically tied to your mortgage payment history and credit score.
Home improvement loans vs. mortgage loans – the pros and cons
There are advantages and disadvantages to both types of loans.
Home improvement loan:
While many homeowners seek to improve their property at some point, the question of how they’ll pay for those improvements is a reassuring one. The most popular options are either taking out a home improvement loan or getting a mortgage. Since both types of loans have their pros and cons and everyone’s financial situation is different, there is no one-size-fits-all answer to which type of loan is better. You should consider your personal situation and may want to consult with a tax or financial advisor to assist you with evaluating which kind of loan works best for you.
Which type of loan has a lower interest rate?
Mortgage loans will have a more favorable interest rate because they are secured loans, meaning you are pledging your home as collateral if you default on the loan. Banks have less risk and charge a lower interest rate because of this.
Do either home improvement (personal loans) or mortgage loans have variable interest rates?
No, both personal and mortgage loans have fixed interest rates. This means your payment will not increase during the life of the loan.
How long do I have to repay a home improvement loan vs. mortgage loans?
Mortgage loans usually have a longer repayment period (up to 20 years) vs. home improvement loans (up to 10 years).