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When Improving Your Home, Don’t Overlook a Personal Loan

By Stephen Sellner | Citizens Bank Staff

Thinking of giving your home a makeover? Whether it’s remodeling the bathroom, opening up the kitchen, or finishing the basement, home improvement projects are as exciting as they are expensive. That’s why they usually require outside financing.

Home equity loans and home equity lines of credit (HELOCs) have become the go-to financing options for these types of projects. And rightfully so, with their lower interest rates and, in the case of HELOCs, flexibility. But they’re not the only solution for every situation and in some cases, a personal loan makes more sense.

When, you ask? Good question. Here are some of those scenarios:

1. When you haven’t built enough equity in your home

There’s a cap on how much you can borrow against your home’s equity. Most financial institutions don’t want you to carry more than 80% of your home’s value in debt, whether that debt is your outstanding mortgage balance or a home equity loan or HELOC.

That requirement can be a non-starter for someone who recently bought their first home. Let’s say you bought a $400,000 home and have only paid off $40,000. That means you’d still have a mortgage balance of $360,000, or 90% of your home’s value. That exceeds the 80% requirement, so a home equity loan or HELOC would not be an option available to you.

Personal loans, on the other hand, are awarded based on your credit and ability to repay the loan (your debt-to-income ratio).

2. When you want a shorter or fixed repayment term

While it’s true that home equity loans and HELOCs tend to have lower interest rates than personal loans, it doesn’t always mean you’ll pay less interest over the life of the loan. That’s because the length (or term) of the loan’s payment also affects the amount of interest paid — the longer the term, the longer you’ll be paying interest. So even if your loan has a lower interest rate, paying low interest for a longer period of time could equal more interest paid in total than a loan with a higher interest rate for a shorter loan period.

In terms of repayment periods, personal loans typically range from 3-7 years. Home equity loans tend to last 5-15 years, while HELOCs have a draw period lasting 5-10 years, followed by a repayment period. Terms will vary by lender.

Let’s say you need to borrow $50,000 to remodel your kitchen. If you took out a personal loan, and paid 10% interest for three years, you’d pay more than $8,000 in interest over the life of the loan. Now let’s say you took out a home equity loan at 5% interest for 10 years — you’d pay north of $13,500 in interest.

Sometimes, a shorter repayment term beats a much lower interest rate. Just make sure you can afford the larger monthly payments that’ll come with a shorter repayment term.

3. When you don’t want your home used as collateral

Home equity loans and HELOCs are secured by the equity you’ve invested in your home. Therefore, if you don’t repay the loan, the lender could eventually foreclose on your home.

Personal loans, on the other hand, are unsecured. That means if you default on a personal loan, lenders cannot foreclose on your home. However, the lender could put a lien on your home, which will make selling it more difficult, and may also pursue your other assets for repayment.

Needless to say, defaulting on a loan is never a good idea. So if you’re not sure you can keep up with your payments, now is not the right time for a home improvement project.

4. When you want to start the project right away

Personal loan applications are quick to process. Sometimes, you can get your money in a matter of days. Applications for a home equity loan or HELOC take longer — there’s more work that needs to be done, such as an appraisal of your home to find its current market value.

What to remember

Don’t misconstrue the above: a home equity loan or HELOC is an excellent way to finance a home improvement project. But in some cases, a personal loan can be a better option. So before you commit to a home equity loan or HELOC, remember to check out personal loan options to see if the terms are a better fit for you.

With any loan, remember to pay attention to the whole picture, not just the interest rate.

More information

Need help financing your home improvement project? A Citizens Bank Personal Loan lets you borrow anywhere from $5,000-$50,000 with no fees. And you typically get your money within two business days. Click here to learn more.

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