It’s the “paper or plastic” of home improvement loans — whether your loan should be secured or unsecured.
Unsecured loans marketed specifically for home improvement are a relatively recent option that’s sometimes preferred over a home equity loan or home equity line of credit (HELOC). Many of the current lenders started making these loans after the home market collapsed over a decade ago, leaving many homeowners with less (or negative) equity.
An unsecured home improvement loan is a personal loan that has no asset attached to it to secure the debt. Unlike home equity loans, these loans do not use your home as collateral or require you to have a certain amount of home equity to qualify.
A key advantage of using an unsecured home improvement loan rather than a home equity loan or HELOC is that the lender can’t foreclose on your home if you default on the loan unless that lender is awarded a judgment by a court.
1. Unsecured loans come in lower dollar amounts.
Because unsecured loans are riskier for lenders, they usually come with lower maximum loan amounts. Depending on your financial situation, most lenders might allow you to borrow up to $50,000, and a few lenders might let you borrow up to $100,000 if you have a large income. Still, the loan amount may not be sufficient to cover the costs of the home improvements you have in mind.
The loan amount you qualify for will be based on your income, debt-to-income ratio and credit score. Taking out a larger loan may mean larger monthly payments, depending on the repayment period. Use a personal loan calculator to estimate what your monthly payments and determine if the loan fits your budget.
2. Loan terms are usually shorter.
Another factor to consider when deciding how to pay for home improvements or home repairs is that loan terms are usually shorter for unsecured personal loans than for secured loans. While home improvement loans usually have terms that range from two to 12 years, home equity loans have terms that range from five to 30 years.
Having a longer repayment term might be better for your budget since your monthly payments could be lower. However, the downside to this is that you’ll end up paying more in interest during the life of the loan.
If you have a lot more than $100,000 worth of equity in your home, you could potentially borrow more money with a home equity loan.
To illustrate, if you get a 10-year home improvement loan for $50,000 with a fixed rate of 8 percent, you’ll pay $607 each month and $22,796.56 in interest over the loan term. But if the term is extended to 30 years, your payment will drop to $367, but you’ll pay $82,077.62 in interest.
3. They are quick to obtain, often with no start-up fees.
Unsecured personal loans are based on your income, debt load and credit history, so they can be as quick and easy to get as a credit card. Also, some lenders offer same-day approval and will deposit your funds into your account as soon as next business day.
In addition, if you search for home improvement loans that have no fees, you can minimize your borrowing costs. Common fees include application fees, origination fees, returned payment fees and prepayment fees, which are penalties for paying a loan off before the end of its term.
If you get a home equity loan instead, you may have to pay closing costs.
4. You may pay higher interest rates without collateral.
If you choose an unsecured loan for home improvement, you might pay a higher interest rate since these loans are riskier for the lender. As of January 2022, rates for home improvement loans range from 3 percent to 36 percent. By contrast, the average home equity loan rate ranges from 3.25 percent to 7.94 percent and the average HELOC rate ranges from 1.99 percent to 7.24 percent.
The rate you receive on your home improvement loan depends on a few factors, primarily your credit score. Generally, the best rates are reserved for borrowers with the highest scores.
5. Unsecured borrowers need good credit.
Want to get an unsecured home improvement loan? To qualify for a large loan amount, you’ll need good credit — a credit score of 670 or more, according to the FICO credit scoring model. If you have poor or bad credit, you might not meet the lender’s minimum credit scoring requirements. Even if you’re approved, you’ll most likely qualify for a lower loan amount with a higher interest rate.
For example, a 5-year, $15,000 loan with a 6 percent interest rate will cost you $2,399.52 in interest. But a loan for the same amount with a 20 percent interest rate will cost you $8,844.50.
If you have bad credit and you’re willing to pay more for a home improvement loan, consider applying for a home improvement loan for bad credit. Some lenders might approve you for a loan with a credit score as low as 580.
To improve your chances of qualifying for a loan or getting a lower rate, you can apply with a co-borrower or co-signer if the lender lets you. Alternatively, you can take steps to improve your credit score before applying, such as paying down debt.
Alternatives to unsecured loans
If you’d prefer to explore other options, consider paying with cash or a credit card.
It could take some time to save up enough to pay for home improvements. The upside is you can complete projects without racking up debt and having to repay lenders for years to come.
You can use a credit card to cover the cost of minor upgrades. If possible, use a balance-transfer credit card that offers an interest-free purchasing period. But you should pay the balance in full before the promotional period ends for this payment strategy to make sense. Otherwise, a small purchase could cost you several hundred or thousands more in interest.