If you’re seeking credit to complete home improvements, you’ve probably found yourself reading about the home improvement loans vs home equity loans debate. These two credit options can both be used for home renovations, so how do you know which one to choose? We discuss the details so you can make an informed and personalised decision.
What is a home improvement loan?
A home improvement loan is a type of personal loan that is used to complete home renovations. Examples include redecorating, upgrading white goods and furniture or more substantial building projects such as extensions, new kitchens or loft conversions.
Secured vs unsecured home improvement loans
Home improvement loans typically can be found as secured or unsecured personal loans.
A secured home improvement loan uses an asset as collateral within the credit agreement. Thai assets can be seized by the lender and sold to recover the debt if the homeowner does not keep up with the repayment terms. The asset typically used in a secure home improvement loan is a property or home equity, but it may also be secured with vehicles.
An unsecured home improvement loan does not list assets as security within the loan agreement. This increases lending risk and can restrict the loan amount available and cause a higher interest rate. However, the lender could still take you to court for recurring payment defaults, and it could lead to bailiffs repossessing your valuable goods.
How do home improvement loans work?
These loans work similarly to most personal loans. The loan is paid to the homeowner as a lump sum and they then make monthly payments that repay the principal loan amount plus an agreed rate of interest. The loan is usually provided within a few days after approval and repayments begin the following month.
A home improvement loan, either as an unsecured or secured loan, will have a fixed repayment period. Once this period is over and all payments have been made, the loan is paid off.
What is a home equity loan?
A home equity loan is a type of secured loan that uses your home equity as collateral and to determine how big of a loan the homeowner can get. You might be able to get up to 80% of your home equity as a loan, and for people with a lot of equity, this means accessing a significant amount of money for big renovation projects.
The loan is paid out in a single payment and then repayments begin immediately with interest added. These payments continue for a fixed term until all the loan and interest has been repaid. However, if you fail to pay back what is owed, the lender can initiate foreclosure, meaning you are forced to sell your home to repay the debt.
Home equity loan vs HELOC
A home equity loan and home equity line of credit (HELOC) are similar but not the same. Home equity lines of credit give the homeowner a draw period where they can access the loan in stages as they need it – a bit like accessing money from a credit card.
During the draw period – which can last years – only variable rate interest is payable and no principal payments are made. After the draw period ends, the principal and interest must start being repaid.
How does a home equity loan work for home improvements?
Home equity loans can be used for an array of purposes, including debt consolidation, to fund holidays and car purchases, education bills and to help younger families buy their own property. But it just so happens that a home renovation project is one of the most popular reasons – if not the most popular reason – that people choose to take out a home equity loan.
Home equity loans work in the exact same way as described above for completing home improvements. In fact, using a home equity line of credit to complete these projects can be beneficial because it helps homeowners split the project into stages within the draw period and avoid overspending.
Should I get a home equity loan for home improvements?
Using a home equity loan to complete home improvements can be beneficial. The advantages are that these loans can help the homeowner get a large amount of credit that may not have been possible with other loans, including unsecured home improvement loans. Having an asset listed as collateral can help increase the loan amount and earn them a lower interest rate, due to decreased lending risk.
Another benefit of using a home equity loan for renovations – which also applies to home improvement loans – is that the project can increase property value, and thus, recoup some of the home equity you borrowed against. This simultaneously mitigates the chances of dropping into negative equity.
What is the difference between a home equity loan and a home improvement loan?
There are minimal differences between secured home improvement loans and home equity loans when they both use the property or home equity as collateral within the loan agreement. In these cases, the only big difference is that a home improvement loan should be exclusively used to fund home renovations, which is not the case with a home equity loan. You could use a home equity loan to fund home renovations and for other purposes.
A HELOC adds further differences to a home improvement loan because of the way it is paid out and repaid. And unsecured home improvement loans are vastly different to HELOCs or home equity loans because they do not use an asset as security, meaning the amount available to borrow and the interest rate are typically not as appealing.
Another potential difference between the two is that home equity loans come with closing costs whereas a home improvement loan may not. However, the latter may include other loan fees.
Home improvement loans vs home equity loans
Because secured home improvement loans and home equity loans are almost identical with some differences, there is no way of exclusively saying that one should be used over the other. The best option will depend on personal circumstances and what each lender is offering within repayment terms, especially additional loan fees and the interest rate.
Always do your research and employ professional help if needed.