Homeownership
How Do Home Improvement Loans Work?
Do you have a home improvement project you’ve been itching to start? Even in a global pandemic, American consumers are expected to spend nearly $365 billion on home improvement projects in 2020 alone.
If you aren’t quite sure how you’ll finance your project, the good news is that you have options. Instead of resorting to credit cards or using their home as collateral, many homeowners opt to take out a home improvement loan.
To get answers about some of the most common home improvement loan questions, we spoke to Paige Hanson, Amplify Credit Union’s Consumer Loan Officer. Here’s what we learned about how home improvement loans work and common mistakes people make when trying to apply.
What Is a Home Improvement Loan?
A home improvement loan is a type of secured loan specifically designed for homeowners looking to complete more substantial projects around the house with a contractor.
Home improvement loans increase your loan-to-value threshold to as much as 95%.”
As you would with other loan types, you’ll have a fixed rate and a fixed monthly payment for a set time (usually up to 15 years).
A home improvement loan is not the same as a home equity loan, home equity line of credit, or a homeowner express loan, even though these also may be used to finance a renovation project.
Unlike a home equity loan, home improvement loans provide homeowners with an increased LTV (loan-to-value) threshold for their loans. Whereas most home equity loans will limit you to borrowing up to 80% of the equity in your home, home improvement loans increase that limit to as much as 95%. This allows borrowers to tackle earlier or more expensive projects after closing on a home.
How Do Home Improvement Loans Work?
Applying for a home improvement loan, in many ways, is similar to applying for any other type of loan. The lender will need to know basic financial information, including your credit score, credit report, income, and other factors that will help determine the loan terms and whether or not you qualify. But there are a few things that make a home improvement loan a little different than an ordinary personal loan.
“Amplify places a mechanic’s lien on the home, which requires us to have only one contractor involved in the loan process,” Hanson explains. “We place the obligation on behalf of the contractor, so they are required at closing.”
A mechanic’s lien may seem a little intimidating, but there’s no reason to fret. This lien ensures that the contractor is guaranteed to get paid first in the event of liquidation (i.e. foreclosure).
What Kind of Projects Are Covered by a Home Improvement Loan?
To help homeowners get an idea of what projects they could finance with the loan, Hanson offered these commonly approved improvements:
- Kitchen renovation
- Bathroom renovation
- Pool installation or renovation
- Fence installation or renovation
- Sidewalk or patio installation
- Outdoor kitchen installation
- Interior floor covering installation
- New roof
- Air conditioning compressor replacement
- Installation of solar panels for electricity or water heating
When it comes to painting projects, don’t get your hopes too high. “Paint is only allowed to the extent that it is incidental to one of the items mentioned above,” Hanson says.
What Happens if the Project Scope Changes Before the Project Starts?
Sometimes people change their mind about some aspect of the project. “Occasionally, a borrower, after closing, will decide to change contractors, the scope of work for an existing contract, or discontinue the project completely,” Hanson explains. “If this occurs, Amplify will make every effort to accommodate the borrower’s requests subject that the amendments do not adversely impact the level of risk.”
This means that changes are often acceptable, as long as it won’t affect your ability to repay the loan or the lender’s risk. Always maintain open communication with your loan officer, who can help you appropriately navigate any changes.
Common Home Improvement Loan Mistakes
There are several mistakes that homeowners often make when searching for the right home improvement loan. Knowing these beforehand can prevent you from falling into the same traps.
The borrower tries to do it themselves
Even veteran handymen must work with a licensed contractor to qualify for a home improvement loan. “Any item completed by the borrower is ineligible for this program,” Hanson explains. Trying to tackle a home improvement project on your own may require a homeowner to seek out alternative funding.
The borrower doesn’t plan far enough ahead
If the timeline for your project is measured in days, not months, you may find that a home improvement loan is not the right fit. Make sure you plan far enough ahead of time, not just for project completion, but for the loan to be approved as well.
“Amplify will not guarantee a loan until we have full approval. We recommend applying and getting the loan process finalized before members do any work on the home,” Hanson suggests. “The loan process can take anywhere from 15-30 business days to complete. We don’t get the final decision on a loan until we get the title/property search back, after the loan application is taken.”
The borrow wants a home improvement loan as soon as they move in
If you move into a fixer-upper and expect to use a home improvement loan immediately to start making repairs, you may be out of luck. There are often requirements as to how long you must first live in the house. “Our guidelines state that you have to reside in the home for at least six months or more,” Hanson says. Of course, exceptions can be made, but they are rare and can only be done with special approval.
The Borrower fails to adequately budget the project
This goes for any big project that you complete: you must take the time to plan and research your home renovations ahead of time. Creating a rough budget is as easy as 1-2-3:
- Outline your project goals. Be specific and list all of the tasks to be completed. If you are redoing your bathroom, break the project down into its component parts. You’ll want to consider each element affected, such as retiling the shower, new hardware, and refinishing the cabinets.
- Do your research. Once you have an idea of what each task will look like, get an estimate of labor and materials. Use online reviews and community pages to see what other homeowners might have paid for this product.
- Adjust if needed. After you estimate what things will cost, you may need to adjust the scope of your project. For example, you may decide that the money that was going to go towards a new sink vanity will be better spent on a new low-flow toilet. Be ready to adjust the loan amount as new information is available.
Creating a budget will ensure that you can afford to complete the renovations and give you an idea of the loan offer you will need.
Conclusion
If you follow the steps outlined above, even a lack of cash may not hold you back from your next project. Home improvement loans are an excellent option for people who want to undertake an extensive renovation project on their house using a contractor. You can get a better rate than a credit card and don’t need a ton of equity built up in your home to take one out.
