Should you use a personal loan for home improvement? It’s often a good idea to do so. But there are times when a home equity loan or even a credit card can be a smarter choice.
So how do you tell when one’s better than the others? Luckily, it’s usually a fairly straightforward choice because it’s mainly governed by how much you’re planning to spend.
Credit cards for tiny home projects and budgets
Suppose you’re going to spend just a couple of hundred dollars or so on paint, tiles or new handles for your kitchen cabinets. There’s often nothing wrong with charging that to your plastic.
Yes, the interest rate you pay is likely to be high. But it adds up to a small amount over a few weeks or months, and the actual cost shouldn’t be more than pocket change, as long as:
- You make more than minimum payments. Pay down the sum over a limited period, usually one, two or three months
- Your purchase won’t mean you’re taking your balance above 30% of your card’s limit. Doing that could hurt your credit score, which could make your next borrowing more expensive
You can always use your plastic to buy things for convenience, or to get rewards. Just charge the purchases, bank your rewards and then immediately zero your card balance with the proceeds of your personal or home equity loan.
Personal loan for home improvement
Personal loans tend to be best for medium-sized budgets. You’re spending between several hundred and several thousand dollars.
Personal loan advantages:
- Typically a much lower interest rate than for credit cards
- Cheap or free set-up costs
- A quick application process that delivers your money fast
- No harming your credit score with excess revolving credit utilization
- Fixed interest rate and payment plan. Plus a definite term (one to five years)
Personal loans don’t let you string out payments forever, and their fixed rate and payments make budgeting easier. A personal loan for home improvements is almost always the best choice when you have a mid-range budget.
Home equity loan vs. personal loan for home improvement
Chances are, you’ll get a considerably lower rate if you choose a home equity loan rather than a personal one. So why not go for that?
No reason, if you’re borrowing enough (think $10,000 or more) to justify the expense and hassle of setting one up. Because those are very real overheads. For smaller amounts, the closing costs on your second mortgage (because that’s what a home equity loan is) can easily eat up all the savings you make through its lower interest rate — and then some.
Benefits of personal loans
Other reasons you might prefer to stick with a personal loan include:
- You’re putting your home on the line with a home equity loan. Fail to keep up payments and your lender has a direct path to foreclosure
- You may not have enough equity (the amount by which the market value of your home exceeds your mortgage balance) to borrow the amount you need
- As with credit cards, home equity loans make it easy to extend your repayment over a very long time. And if you repay your loan over a 30-year period, your interest costs more, even at a lower rate, than it would with a personal loan over a five-year term
When to consider home equity financing
There are times when home equity loans make more sense than personal loans:
- You’re borrowing enough to justify the closing costs
- You are confident you won’t fall behind with payments
- You have enough home equity to borrow against
For the same borrower, home equity loans generally come with lower interest rates than personal loans. They may also deliver tax benefits on borrowing for home improvements, though you need to check with a professional advisor before relying on those.
Comparing financing alternatives for home improvements
To decide how you should finance home improvements, look at these factors:
- How much do you need? Your loan amount is limited by your home equity, credit card limit and/or maximum affordable monthly payment
- What can you afford each month? If the payment for a personal loan is higher than you can afford, credit cards or home equity might be your only choices
- What are the setup costs of each loan? These are part of your total costs
- What is the interest rate for each loan? Lower is better than higher, naturally
Here is a sample analysis for a hypothetical borrower who wants to borrow $10,000, has excellent credit and can afford a payment of $500 a month. Note that costs increase substantially if you only make the minimum payment.
How low a rate will you be offered? The only way to find out is to request some quotes.