People have plenty of options when it comes to financing home improvement projects. Therefore, we broke down the pros and cons of the fifteen most common programs.

Consumers without enough equity in their property can tap into unsecured personal loans and credit cards that do not require you to pledge collateral.

Individuals with a bad credit history can often qualify without a credit check from one of the big three consumer reporting agencies – if they meet alternate score requirements.

Those with enough equity enjoy lower borrowing costs and longer repayment terms (lower payments but more time for interest to accrue) via secured contracts – but risk losing their house in default.

Government insurance provides guarantees to lenders for marginal applicants.

Unsecured Financing with No Equity

Unsecured financing programs support home improvement projects for consumers with little or no equity in their real estate property. The word unsecured means that you do not pledge an asset as collateral.

  • The lender relies on your signature promise to pay
  • You do not face foreclosure in the event of default
  • Underwriting is faster and requires less paperwork

Personal Loans

Personal loans are an ideal choice to fund home remodeling for borrowers with no equity because they are unsecured. The lender will only consider your credit history and score, plus your income and employment history.

Long-term personal loans have the lowest monthly payments, making it easier to afford, finishing your basement, modernizing your kitchen, adding an extra room, or updating your bathroom. Terms can extend up to 5 years for the most qualified applicants.

Personal loans are installment arrangements with fixed monthly obligations and pre-defined end date. You gradually retire the debt (amortize) with each payment, unlike with a credit card.

Credit Cards

Consumers frequently turn to credit cards to fund smaller home remodeling projects when they have little or no equity. Credit cards are also unsecured but are revolving contracts. Revolving accounts feature preset borrowing limits and flexible payment arrangements that get many borrowers into debt trouble.

Homeowners can choose between two types of these revolving accounts.

  1. General-purpose credit cards work well when you have enough “open to buy” on your existing account. Open to buy is the account limit minus the outstanding balance. Beware that you will incur hefty interest charges if you revolve the balance (pay less than the full balance each month).
  2. Private-label credit cards available through retailers and contractors often feature zero-interest promotional periods. However, read the fine print about how “deferred interest” works. If you fail to retire 100% of the balance within the promotional period, you pay an extra high rate (29%) from the date of purchase.

Home Improvement Loans Bad Credit History

Be very careful about taking out a home improvement loan when you have a bad credit history or low FICO score. Your record indicates that a future default is far more likely. Therefore, take special precautions and be aware of the consequences.

  1. Borrow money only for needed work such as rusty pipes, leaky roofs, drafty windows, cold furnaces, and hot air conditioners.
  2. Steer away from over-extending on luxury items such as upgraded kitchen cabinets, finished basements, additional rooms, cedar decks, in-ground swimming pools, or hot tubs.
  3. Avoid using the equity in your home as collateral. You risk losing your house in foreclosure if you fall too far behind on payments.
  4. Expect to endure higher borrowing costs (origination fees, and interest rates) for unsecured debt (no equity), and have higher monthly payments because the repayment terms will be shorter.

Minimum Credit Score

Many people ask about the minimum credit score needed for a home improvement loan when they have a bad history or rating. However, the bottom score requirement will vary because it is only one of three possible underwriting factors.

Most lenders will be flexible around any single approval criteria when the applicant performs well on the other counterbalancing factors.

  1. Minimum FICO score of 660 for unsecured and 600 for secured
  2. Maximum Loan to Value (LTV) ratio of 80% for many secured contracts
  3. Maximum Debt to Income Ratio (DTI) 36% for secured and 28% for unsecured

Look at your entire profile, rather than any single element like a credit score, when estimating your borrowing qualifications. Include all three components (Rating, LTV, and DTI) and supporting details. For example, someone with a steady job with a long-term history with a single employer has the most reliable future income stream to back the DTI and overcome a poor history or rating.

No Credit Check

Home improvement loans without a credit check are unsecured by default. Mortgage underwriting rules require three report pulls (merged file compiled from Equifax, Experian, and TransUnion files). Therefore, bad credit borrowers should not look to equity-based options.

Many online lenders will approve unsecured loans without a credit check from the big-three bureaus (Equifax, Experian, and TransUnion). Instead, they may pull a file from one of many second-tier consumer-reporting agencies that compile non-traditional financial data.

Income and affordability are extra important when the lender forgoes using a traditional consumer report and credit score. Make sure that your projected debt-to-income ratio is within accepted ranges, and provide your employer contact information so the lender can verify your work history.

Secured Improvement Loans with Equity

Secured home improvement loans tap into the equity in your real estate property. Secured contracts require the owner to pledge their house as collateral, which means that the lender can foreclose on the property in the event of default.

In other words, think twice before putting your living space at risk over an upgraded luxury item. Of course, lenders do not want to deal with defaults and foreclose, so they impose particular criteria upfront to make sure borrowers have enough skin in the game: three possible forms of the Loan-to-Value ratio.

  1. LTV is the ratio of the mortgage balance divided by the property value and triggers three magic thresholds
    1. Below 80% for conventional mortgages without insurance premiums
    2. Less than 95% to be eligible after paying private mortgage insurance
    3. Below 97% to be qualified government-backed insurance guarantees
  2. CLTV is the combined LTV which considers the balances on all contracts secured by the property
  3. HCLTV is the high combined LTV which includes the account limit (not balance) on any revolving lines of credit (HELOC)

Home Equity Loans

Home equity loans are a type of second mortgage that you can use to fund remodeling rooms and upgrading fixtures. For most borrowers, the CLTV (primary plus secondary mortgage) needs to be 80% or below. Most lenders will consider the current value of your property, rather than a projected estimate at project completion.

Pros Cons
Possible tax deduction Risk of foreclosure
Lower interest rates Incur closing costs
Longer repayment terms More time for interest to accrue
Lower monthly payments Need enough equity

Cash-Out Refinance

Cash-out refinancing funds home remodeling projects by replacing the existing mortgage with a bigger loan. The new mortgage pays off the old, and the borrower retains the difference to spend how he or she wishes.

A thirty-year repayment term option is the double-edged sword of a cash-out refinancing. Weigh both sides before taking the plunge.

  • Pros: a thirty-year term has the lowest monthly payment making it easier to afford and avoid a possible default and foreclosure
  • Cons: a thirty-year length on a new mortgage extends the horizon on debt retirement and invites a future repeat episode

Home Equity Line of Credit

A Home Equity Line of Credit (HELOC) can finance rehabilitation tasks via a revolving contract. A HELCO is very different from a home equity loan, which is an amortizing installment arrangement with fixed monthly payments and predefined repayment periods.

A HELOC works like a credit card in many ways – except that you secure the contract with the equity of your real estate property (up to 85% HCLTV).

  • Preset account-borrowing limit
  • Ability to draw on the account as needed
  • Flexibility to make payments of any size above the minimum
  • Payments replenish the available credit
  • Interest compounds based on the daily balance

The term of a HELOC is typically 30 years: 10-year draw period, 20-year repayment period.

Construction Loans

Construction loans represent an interim financing tool for more expensive home remodeling efforts. With this option, the lender bases the available equity on the projected value of your property after the contractor completes the work.

The lender relies on an estimate of future value and trusts that the contractor is competent, reliable, and will finish the job according to schedule. Therefore, expect a more involved underwriting process, higher borrowing costs, and other hurdles.

  • Substantial down payment requirements (up to 35%)
  • Funds disbursed to the contractor in phases
  • Short repayment terms
  • Interest-only payments
  • Final mortgage to retire the balance

Government Home Improvement Loans

Federal government home improvement loans always required the applicant to pledge their real estate property as collateral to secure the contract. The government does not issue the funding but works behind the scenes to make borrowing more accessible and more affordable in two different ways.

  1. Government-Sponsored Enterprises (Fannie Mae and Freddie Mac) support a secondary market that allows banks to concentrate on originating additional mortgages. The GSE entities work primarily with conventional financing products.
  2. Government agencies support guarantee programs that protect lenders from loss in the event of foreclosure. Consumers may pay a monthly premium for insurance. In exchange, they can qualify with little money down and or very high LTV ratios compared to conventional mortgage products.

Fannie Mae

The Federal National Mortgage Association (Fannie Mae) government-sponsored enterprise providing reliable, affordable mortgage financing in all markets at all times.

The Fannie Mae Homestyle Renovation Loan allows borrowers to rehab or update their primary residence. Fannie Mae calculates the LTV by considering the proposed project’s cost and anticipated increase in appraised value.[1]

  • LTV up to 97%
  • Limit of renovation funding is 75%
    • Of the purchase price plus project expenses, or;
    • Of the completed appraised value

Freddie Mac

The Federal Home Loan Mortgage Corporation (Freddie Mac) is a government-sponsored enterprise with a mission to provide liquidity, stability, and affordability in the housing market.

The Freddie Mac Renovation Mortgage appeals to consumers who need permanent financing instead of interim construction loans. Borrowers can use the funding for two purposes.[2]

  1. Repair, restore, rehabilitate, or renovate their existing site-built homes
  2. Make additions to existing site-built homes

HUD

The US Department of Housing and Urban Development (HUD) is a government agency whose mission is to create healthy, sustainable, inclusive communities and quality affordable residences for all.

HUD programs primary supports real estate investors who focus on buying and rehabilitating apartments and multi-family homes and select ethnic groups. Meanwhile, The Federal Housing Authority (FHA) is a subsidiary agency operating under HUD concentrates on ownership of single-family dwelling units.[3]

Section 184

For example, The HUD Section 184 Indian Home Loan Guarantee Program is available to members of Native American tribes and villages. Applicants can use the funding to rehabilitate their property – including weatherization.

203K

The FHA 203K Renovation Loan program allows borrowers to bundle the financing for both the purchase and rehabilitation into a single contract. The 203K lender disburses a portion of the money to fund the purchase and holds the remainder in escrow until completion of the restoration project.

You can use the 203K money to pay for a variety of alterations and construction.

Flooring

Landscaping
Disabled modifications Energy conservation Foundations

Title 1

The FHA Title 1 home improvement loan is another government-sponsored financing option. The Federal Housing Authority (FHA) insures private lenders against losses. The consumer-funded ($1 per $100 borrowed annually) insurance makes it easier for private lenders to approve marginal applicants.

The homeowner must use the FHA Title 1 funding to improve the basic livability or utility of the property. You have two options with different provisions for single-family dwelling units.

Type Max Amount Repayment Term
Unsecured $7,500 6 Month Min
Secured $25,000 20 Years Max

USDA

The US Department of Agriculture is a government agency that attempts to help advance the economy and quality of life in the American countryside. The USDA Section 504 Home Repair Program provides loans to very-low-income homeowners to restore or modernize their property.

Section 504 applicants must meet strict criteria.

  1. Live in an eligible rural area
  2. Be unable to obtain affordable credit elsewhere
  3. Have a family income below 50 percent of the area median income

VA

The Veterans Administration is a government agency that helps service members, veterans, and eligible surviving spouses become homeowners. The VA provides a loan guaranty benefit to help their target population buy, build, repair, retain, or adapt a home for personal occupancy.

The VA guarantee allows eligible people to qualify for secured mortgage products without making a down payment or paying premiums for mortgage insurance. VA rules also limit closing costs.[4]

  1. Purchase mortgages
  2. Cash-out refinancing
  3. Renovation loans

Sources:

[1] Fannie Mae

[2] Freddie Mac

[3] HUD Home Improvements

[4] Veterans Administration