Let us start off by defining what a home improvement loan is, then we will get into expectations vs. reality. Home improvement loans are generally short-term loans that are advanced for improvements to a residential property. They are generally used for remodeling, additions, maintenance, repairs, or structural improvements or parts.

Expectation:

You will receive the entire sum of money borrowed at one time.

Reality:

Generally home improvement loans are disbursed according to the work schedule. The lender may disburse 30% in the beginning of the project then disburse smaller increments that coincide with project milestones. Oftentimes, the lender will hold onto a small percentage of the loan until after the work is completed and the borrower confirms he or she is satisfied with the results.

Expectation:

Applying for a home improvement loan is similar to applying for a mortgage.

Reality:

Nope, not at all. A home improvement loan is very different from the mortgage process because lenders will want to see a thorough outline on how you plan to use the money. They will want to see at least one estimate, a detailed timeline for each milestone, and how much money is allocated to complete each step.

Expectation:

I cannot get a home improvement loan because I do not have enough equity in my home.

Reality:

The advantage of a home improvement loan is that borrowers can receive an unsecured loan while having insufficient equity, as long as the entire loan is used to improve the property. Hence, why lenders will want to see a thorough outline of how the money is spent. Typically, when a home does not have enough equity to qualify for a home loan, the borrower would take out a 2nd mortgage. The benefit to that is the low interest rate, but there are closing costs to consider. This is the disadvantage of a home improvement loan, because it is unsecured, the interest rates may be higher than a 2nd mortgage. However, the improvements to the property will most likely increase the fair market value (FMV), which is attractive to lenders.

Expectation:

A home improvement loan is the same as a home equity line of credit (HELOC).

Reality:

These are two very different loans, and they have very different requirements, terms, and rates. A HELOC is a line of credit that can be used at the borrower’s discretion. Thus, a borrower does not need to use the entire line of credit if they don’t need it, which can save them money on interest. Generally, HELOCs have lower interest rates which make them more attractive to borrowers. However, because a HELOC is a secured loan, to qualify, borrowers must have adequate equity in their home. A borrower can request a loan amount based on the home’s FMV, subtracting the first mortgage balance. Most lenders will approve a maximum HELOC of 80% of the FMV. Unlike a home improvement loan, another advantage of a HELOC loan is the borrower can use the money for any purpose desired.