Categorized | Home Loans

How to Get a Home Improvement Loan

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Home improvement loans for repairs or renovations are often a necessity and often cost more than we have saved on hand. While debt is not always ideal, sometimes a home improvement loan is the right choice. Today we will review a couple different types of loans you can take out, the pros and cons of these loans and how to get approved for one. 

About Home Improvement Loans

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There are a couple types of home improvement loans:  secured and unsecured. A secured home improvement loan is essentially a second mortgage. You get a home equity loan by putting your house up as collateral. The interest you will pay will be much less than if you took out an unsecured loan for a home improvement project. Furthermore, since it is considered a mortgage, all interest you pay will be tax-deductible as current tax laws stand.

Home Equity Line of Credit

A home equity line of credit differs from your traditional home equity loan in a few ways. First of all, it is a revolving line of credit rather than an installment loan, so it acts like a credit card with your home as collateral. Interest payments are deductible, but interest rates will be higher than if you took out a standard home equity loan. Furthermore, having an open credit line may cause people to spend more than they can afford once they pay the loan balance down and see the open credit still available. However, you are only charged interest on the amount you borrow, so you can make gradual improvements over time as necessary.

Unsecured Loan

There are many reasons people choose to take out an unsecured home improvement loan. Typically, this type of borrower has a higher credit score so is less worried about the interest rate or needs a much smaller loan amount. They also plan to pay the loan back in less than 10 years and do not itemize their deductions.

Pros & Cons

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There are both pros and cons to both secured and unsecured home improvement loans.

Pros 

Home improvement loans are good for cash flow. Even if you have the money saved up for a home improvement project, it can still be quite a sting to spend all that money at once. They are also ideal for those who do not have enough money saved up but have good credit. Putting off repairs can be costly and cause significant damage to your property if left unfixed. If you are strategic, you can spend this money to improve the value of your home more than the total cost of the loan. This is a pro for anyone not living in their forever home, no matter how long you plan on staying at your current residence.

Cons

Like many decisions in life, there are also cons to a home improvement loan. If you take out a home equity loan and for some reason cannot pay both mortgages for six months, your house can be foreclosed on, and you will lose your home. If you improperly vet your contractor, you can suffer from massive amounts of damage which will tank the value of your home. Mitigate this risk by using contractors recommended by your friends and family or real estate agent. Finally, if your local economy is struggling when you take out a loan, interest rates will be higher if you receive a loan from a local credit union rather than a national lender.

How to Get a Home Improvement Loan

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There are only a few, simple steps that stand between you and your first home improvement loan.

Estimate the Cost

First, ask contractors to give you quotes for the scope of project you desire. Add 10% to the bid you receive from your favorite contractor to account for unexpected necessary repairs or other expenses. Consider how much of this amount you can comfortably pay with savings. Also, consider if you will be paying this amount from investments. Calculate the average return you are getting on these investments versus your expected interest rate and any tax consequences of withdrawing this money. The more you can pay out-of-pocket, the less interest you will pay over the life of your loan and the lower the monthly payments will be.

Check Your Credit Report

Hopefully, you are tracking your credit score through your bank or credit card provider on a monthly basis. However, your interest rate will be most heavily determined by your credit report. In the United States, you are entitled to one free credit report each year. Make sure there are no discrepancies, such as fraud or other inaccuracies, that will make you look more risky to potential loan providers. Also, resolve any outstanding issues that are legitimate before seeking a loan.

Get an Appraisal 

If you are getting a secured loan, get an appraisal to determine the value of your home which will allow loan processors to calculate the equity you have in your home. If you are getting an unsecured loan, you can skip this step.

Shop around

If choosing a secured loan, avoid loans that put you in debt greater than 80% of your home's market value. This protects you if you sell the home before you pay off the second mortgage. Speak to your local bank or credit union and current mortgage provider. Then, shop around online. Remember to not look at only one aspect of the loan terms. Longer loans have lower monthly payments, but you will pay more interest over the life of your loan. They may also come with a higher annual percentage rate which is even worse for you.

Check your eligibility for a Title I Home Improvement Loan. It is guaranteed by the FHA, so it is seen as low-risk which means a lower interest rate for you. Furthermore, if you take out a Title I loan for less than $7,500, you do not have to make a pledge of equity meaning you do not have to pay for an appraisal. The downside is you may be required to make a down payment.

Gather Necessary Information

Make sure you have all necessary documentation, such as the estimate from your contractor, pay stubs, proof of additional taxable income and a couple years of 1040s. Your loan provider may also require other supporting tax documentation.

Get Pre-Qualified

You can provide your desired lender with your financial information without providing documentation. You may be pre-qualified over the phone, online or in person. Once you are pre-qualified, you will be told how much you can borrow. If this amount is inadequate, work on repairing your credit.

Get Pre-Approved

You can get approved for a home improvement loan in-person by gathering all necessary documentation and driving to the bank once, but that takes a lot of time waiting at the bank and limits your options to financial institutions. You may also be required to email or fax over additional documentation, so it is much easier getting pre-approved online.

Review and Sign

Once you have applied for a loan and been approved, review the APR, loan length and other terms, such as pre-payment penalties or the ability to refinance. If you are unclear on any of the terms, do not sign. Find a lawyer to review the terms, and ask the loan provider to redraft the document with any changes you may require.

Loans with Bad Credit

If you need a home improvement loan, have poor credit and do not have time to repair your credit before needing a loan, you can still be approved. If possible, ask a parent or grandparent to co-sign the loan for you. Their credit score will average with yours and result in a lower interest rate than you could have gotten on your own.

You may also add a truck, boat, motorcycle or other high-value personal property you own as collateral for your loan. Then, you have more at stake, such as the vehicle you need every day for work, and the lender has less risk because they have an asset they can repossess and sell if you become delinquent. Finally, there are specialty lenders who will lend you money at much higher interest rates to mitigate their risk.

Conclusion

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Depending on your situation, a home improvement loan can be a great decision. If used strategically, you can improve the value of your home by more than the total loan amount before you sell. Just make sure if you take out a second mortgage, your total amount owed is less than 80% of the home's fair market value. This will protect you if you have to sell the home.

There are pros and cons to all types of these loans, so do your research. When you are ready, get quotes for the cost of the project and add 10% as a buffer. Then, decide how much you want to borrow, and get your financial house in order. Finally, get pre-qualified, pre-approved, approved, review the terms carefully and sign knowing you have done your due diligence:  you have a good contractor, and you have great loan terms for your home improvement. 

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