How to get the best home improvement loan rates

Renovations, repairs, and updates may add value to your home and improve your quality of life. However, these projects may often come with a hefty price tag.

One of the easiest ways to finance these projects is with a home improvement loan, which allows you to borrow money for the purpose of improving your home. When taking out a loan, the accompanying interest rate is an important factor to consider when planning your budget. With many options to choose from, getting the best home improvement loan interest rate depends on several factors.

Home improvement loans can be secured options (where your home is used as collateral) such as a home equity loan or cash out refinance. If you don’t have enough equity available in your home, you can choose an unsecured option such as a personal loan, although these will likely have lower borrowing limits and higher interest rates than equity financing options. Your personal financial situation and the type of loan and terms you choose will influence your interest rate.

5 ways to earn best home improvement loan rates

How can you get a good rate on a home improvement loan? Here are five strategies that may help you lock in a lower interest rate.

1. Check your credit score: Before applying for a loan, you may want to know what your current credit score is. A higher credit score may likely result in offers for lower interest rates and better loan terms. If your credit score needs improvement, consider taking steps to raise it before you submit a loan application.
2. Shop around and compare lenders: You don’t have to settle for the first loan offer you come across. Instead, compare loan rates and terms from multiple lenders. Some lenders offer to cover costs such as application fees or origination fees which you may want to consider before deciding on a loan. This may help you find the option that works best for you and save you money in the long run.
3. Consider a secured loan: If you have equity in your home, you may find lower home improvement loan rates by using your home as collateral for the loan. This is known as a secured loan and includes options such as a home equity loan or cash out refinance.
4. Reduce the amount you plan to borrow: If possible, you may want to consider requesting a lower loan amount to finance your home improvements. This may qualify you for a lower interest rate on a loan.
5. Shorten your loan term length: Shortening the length of the loan, or how long you have to pay it off, may help you get lower interest rates. While this will likely mean a higher monthly payment, it may mean fewer interest charges over the life of the loan — keeping the overall cost of the loan down.

How home improvement loan rates are calculated

Lenders calculate home improvement loan rates using the information you provide in addition to other data such as your credit score to help them get an understanding of your finances. In general, if you have less existing debt and a higher credit score, you may be eligible for lower rates.

You debt-to-income (DTI) ratio is a detail that lenders may look at to determine the interest rate they will offer to you on a home improvement loan. This ratio is found by adding up your existing monthly debt payments with the anticipated monthly payment on a new loan and dividing that sum by your pre-tax monthly income. Then multiply that number by 100 to find the percentage amount.

If your monthly income is $6,000 and your expected debt payments add up to $2,580 per month, then your DTI ratio would be 43% ($2,580 ÷ $6,000 = .43, and .43 x 100 = 43%).

If you’re considering a home equity loan, another factor lenders will calculate is your combined loan-to-value (CLTV) ratio. This is determined by adding the amount of any existing mortgage obligation and any additional amount you want to borrow and comparing that to the value of your home.

For example, if your home is worth $500,000 and you are applying for a $100,000 home equity loan and have an existing mortgage balance of $300,000, then your CLTV would be equal to 80% ($400,000 ÷ $500,000). In general, a higher a CLTV ratio will result in a higher interest rate.

Types of loans for home improvements

Three common types of home improvement loans include home equity loans, cash out refinancing, and personal loans.

Home equity loans

A home equity loan is a second mortgage that you can qualify for using the equity you’ve built up in your home.

Home equity loans are convenient because you get a lump sum of cash at a fixed interest rate, so your monthly payment stays the same over the loan term. However, they typically take longer than unsecured loans to process, similar to purchase mortgages. During the home equity loan process, a lender may require an appraisal to assess the current value of your home and determine the amount of equity you have available.

Because these loans use your home as collateral, they usually have better interest rates compared to unsecured options such as personal loans. Plus, you may be eligible to claim a tax deduction on the interest when the funds go towards home improvements. Make sure to consult a tax advisor for information about your unique situation and potential eligibility.

Cash out refinancing

A cash out refinance loan may also offers low, fixed refinance rates, but with a cash out refinance, you take out larger amount than what you owe on your home, pay off your first mortgage, and keep the difference to use for your home improvement project. Because this loan replaces your mortgage with a new one and draws from your home equity at the same time, the time it takes between submitting an application and closing the loan may be similar to the length of time it takes to get a home equity loan.

Borrowers like this option because they retain just one mortgage payment. Plus, you may be able to claim a portion of cash out refinance interest payments as a tax deduction (again, consult a tax advisor to see if this situation may apply to you).

Personal loans

You can also use a personal loan to finance your home improvement project.

Personal loans are sometimes approved in just a day, and they don’t require your home as collateral. This means you don’t risk foreclosure on your home if you default. These loans may have fixed monthly payments, but usually have a shorter term. The drawback to personal loans is that they typically have higher interest rates than home equity loans or cash out refinances, even if you have excellent credit. You also can’t claim the interest as a tax deduction, which might be possible with some home equity loans.

Benefits and risks of using a loan to finance home improvements

Some reasons you may want to consider taking out a loan to finance your home improvement projects include:

• Increased home value: Investing in home improvements may increase the value of your property, potentially allowing you to sell your home for a higher price, increase your home equity, or refinance your mortgage at a lower interest rate.
• Improved quality of life: Renovating your home may improve your living space, making it more comfortable and enjoyable for you and your family.
• Potential tax deductions: If you are taking out a home loan to finance home improvements, there are some cases when the interest on that loan may be tax-deductible and help to offset the cost of the loan. Check with a tax advisor to see if this applies to you.

Potential risks involved in taking out a loan for home improvements include:

• Debt accrual: Taking on a loan means taking on debt, which may be a burden if you’re already finding it difficult to manage your finances.
• Risk of foreclosure: If you take out a secured loan such as a home equity loan or cash out refinance loan and fail to make payments, you might risk losing your home to foreclosure.
• Over-improvement: It’s possible to over-improve your home, meaning you invest more money in renovations than you can see back when you sell the property. This may result in an overall financial loss.