Home equity loans vs. home improvement loans: Everything to know

Despite the Federal Reserve’s best efforts, inflation has held firm. Due to that, the Fed held firm, keeping the federal funds rate steady in March. This benchmark interest rate influences the cost of borrowing. Together, higher costs of goods and higher rates can put a damper on your cash flow. 

Homeowners who are looking to renovate or upgrade their homes may be looking for financing to help. Two ways to access cash for home upgrades include home equity loans and home improvement loans. Here we cover how each option works.

Find out how affordable home equity borrowing could be now.

Home equity loans vs. home improvement loans: Everything to know

A home equity loan is a financing tool available to homeowners with sufficient equity. You can typically borrow around 80% to 85% of your home equity. 

“A home equity loan is a secured loan, which means that it’s backed by the value of your home, so it’s collateral. So you’re borrowing a lump sum, typically at a fixed rate and paying it in equal monthly installments,” says Nadia Evangelou, senior economist and director of real estate research at the National Association of Realtors.

Home equity loan terms depend on the specific lender but generally range from five years to 30 years. As home equity loan interest rates stay the same during the term, you get predictable monthly payments. 

One of the major benefits of a home equity loan is that it doesn’t affect your existing mortgage rate. It’s sometimes referred to as a second mortgage. So, if you don’t want to compromise your low mortgage rate, this can be a great option for borrowing. The primary downside is that you put your home at risk of foreclosure if you default on the loan. 

A home improvement loan is generally a personal loan used for renovating or upgrading your home. Like a home equity loan, it also typically comes with fixed rates. But there are major differences to consider as well. 

“So a home improvement loan is usually unsecured…they don’t use their home as collateral. But the thing is that it has higher interest rates, so this is the catch there,” says Evangelou.

As there’s no collateral on the loan, home improvement loan lenders make up for that with higher rates. Your credit score, among other factors, can also influence your rates.  

When it comes to repayment, home improvement loans come with much shorter terms. Typically, this can range from one to seven years, depending on your lender. 

Compare your top home equity loan rates online today.

Why a home equity loan could be better to borrow now

A home equity loan allows you to utilize the equity you’ve built in your home as a borrowing tool. Due to the collateral, it’s not as risky for lenders, which can translate to better rates and terms. 

“If you have the ability to do a home equity loan, you’ll often have more favorable financing terms in the long run,” says Mark Worthington, a loan officer and branch manager at Churchill Mortgage.

So, if you’re looking for the most competitive rates and terms and have sufficient equity, a home equity loan could be a good option right now. Average home equity loan interest rates can be around the 8.5% range. 

It can also be a good choice if you’re doing major work on your home that requires a substantial investment. Evangelou recommends a home equity loan for large-scale renovations due to the lower rates and collateral. For those planning to stay in their home for a while, it can also be a smart move. 

“Often when someone is doing home improvement work, it’s for a house that they intend to remain in for a long period of time. Then they’re doing things from a comfort and a personal standpoint,” says Worthington. He adds that if you’re doing home improvements with the express purpose of improving your home for resale, you might do things differently. 

A benefit of going the home improvement route is that you also may qualify for home equity loan tax deductions. You may be eligible to deduct interest when you use a home equity loan to “substantially improve” your home, according to the Internal Revenue Service (IRS). Be sure to discuss this with a vetted tax professional. 

Why a home improvement loan could be better to borrow now

Evangelou says consumers who “only need $10,000 for cosmetic updates and don’t want to deal with an appraisal, closing costs” may be a better fit for a home improvement loan. It will likely be a faster option, as home improvement loan lenders may be able to offer quick funding. Due to this convenience, if you need to make a time-sensitive repair or upgrade, a home improvement loan can be a good option. 

If you haven’t amassed enough home equity yet or don’t want to put your home at risk, a home improvement loan can be a preferable choice. However, expect higher interest rates on this type of unsecured loan. 

Depending on the lender, your credit, and other factors, home improvement loan interest rates could be in the double digits. For example, Wells Fargo home improvement loans have an APR range of 6.99% to 24.49%. 

The bottom line 

If you’re in a cash crunch or want to preserve your existing cash flow, securing financing can help you pay for home upgrades. Home equity loans and home improvement loans can both help you reach your end goal. But they have very different rates, terms, and funding timelines. One is secured, while the other is unsecured. 

Take all of these factors into consideration when deciding which is the best fit. Do your research on home equity loan lenders and home improvement loan lenders before submitting an application. 

Home equity borrowers can also look into a home equity line of credit or HELOC, which can offer more flexibility. Be aware that unlike home equity loans, which have fixed rates, HELOC interest rates are typically variable. 

Whatever type of loan you use, run the numbers and make sure you can afford the monthly payments. That way, you can have an upgraded home while not harming your finances.