What Type of Loan Is Best for Home Improvements?

With the abundance of time spent at home this past year, homeowners have realized all of the hidden potential. Whether you're opting to do room-by-room upgrades or expand an outdoor living space, you're likely wondering if there is a way to finance such an expense? According to Colleen McCreary, chief people officer at Credit Karma, this is possible with a loan. However, how do you tell which loan is right for your home improvement? McCreary says that homeowners have three loan options: a home equity loan, a home equity line of credit, and or a personal loan. Here's how to decide which one is right for you.

Home Equity Loan

Think of this loan as a secured loan. In its terms, you are agreeing to use a property—in this case, your home—as collateral. McCreary shares that your potential lender will determine the amount you qualified to borrow on a few dynamics including the equity you have in your home. This can be determined by subtracting how much you still owe on your mortgage from the home's market value.

Home Equity Line of Credit

A home equity line of credit, also known as HELOC, is an additional secured home improvement loan. McCreary explains that while similar to its counterpart, the home equity loan, there is a big difference between the two. "While it's similar to a home equity loan, there's a big difference in how the money is disbursed," she says. "You'll be approved for a specific amount of credit, but you won't receive the money in a lump sum like you would with a home equity loan. Instead, you'll be able to borrow money up to your set limit during a draw period (the time frame during which you can withdraw funds)."

Personal Loan

Unlike the two loans above, a personal loan can be unsecured. Here, no property is used as security. A personal loan for this reason may have a higher interest rate as it is considered a greater risk for the lender.

Which one is right for you?

So which home improvement loan is the right one for you? Well, that depends on the homeowner as well as the home project. McCreary explains that home equity loans are beneficial for a specific project such as a home remodel as they can be taken in a large lump sum. On the other hand, a HELOC is great for several smaller projects over a longer time period. Lastly, personal loans are great options for new homeowners who have a good credit score but not much home equity yet. "Just make sure you can stomach any potential rate changes or balloon payments that might apply if you go this route," advises McCreary. "And remember to read your terms thoroughly so that you understand the fees and any restrictions involved."