Home Improvement Loan vs Home Equity Loan: Which is Better?

Whether you’ve just moved into a new house or you’re spiffing up a long-term place, home improvement projects are not cheap.

The average kitchen remodel, for example, cost $25,656 in 2022, according to home improvement guru Bob Vila. Other parts of the home (like a bathroom or garage) cost about half that, but these expenses can add up — particularly if you’re remodeling an entire house. That’s a lot more than you want to put on a credit card.

Many homeowners overcome this challenge with a loan to cover remodeling costs and improve their home’s value — but how do you know whether a home equity loan or a home improvement personal loan is better for your situation? We’re here to help.

What’s the difference between a home equity loan and a home improvement personal loan?

Isn’t a loan… a loan? At its most basic, yes. But some nuances distinguish these two types of loan options.

What is a home equity loan?

A home equity loan, or second mortgage, leverages the money you’ve already paid towards your house — your home equity — as a guarantee to the lender that you’ll repay the loan offer. This is a type of secured loan, in this case, secured by your house, which the lender can seize in a foreclosure should you fail to make your payments. Typically you can borrow up to 85% of your home’s equity, and the loan is made for a fixed amount of money, in a lump sum. Unlike a first mortgage, you generally don’t need a down payment for a home equity loan.

Home equity loan terms tend to be around 15 years, but can range from five to 30 years. Rates for these loans currently hover around 6-7%, the average rate being 6.98% in 2022. A home equity loan has similar interest rates, but is distinct from a home equity line of credit (commonly known as HELOC), which acts as a revolving line of credit rather than a one-time installment.

What is a home improvement personal loan?

A home improvement personal loan, on the other hand, is an unsecured loan, so the lender takes on additional risk. As such, personal loans have higher interest rates than those for home equity loans depending on your credit score. A higher interest rate means you will make larger interest payments over the life of the loan.

These loans are personal loans applied toward home improvements, and repayment terms are therefore shorter — generally a few years at the most. If you don’t make your loan payments in the repayment period, the lender can send your account to collections (which will be marked in your credit history), but does not have the right to seize your house or other assets.

How are home equity loans and personal loans similar?

Both a home equity loan and a home improvement personal loan function similarly once you’re approved — you’ll receive the loan amount, make monthly payments to the lender, interest will accrue as time passes, and the rate you’re given when you apply stays the same since they’re both fixed-rate loans. And you can use the funds to improve the market value of your home.

Home equity loan vs. home improvement loan

When a home improvement loan makes more sense

There are a number of factors that can make a personal loan a better option than a home equity loan for your financial situation.

Securing a personal loan is easier and faster

First, personal loans are generally easier and faster to get. Applying for a home equity loan requires a lot of paperwork as it’s similar to a mortgage. You’ll need to prove your creditworthiness — in fact, you’d better start gathering your past two years of financial documents if this type of loan is your first choice.

Most personal loans, on the other hand, will require only basic documentation to verify your identity and income. In addition, personal loan applicants typically receive a loan decision within days, as opposed to weeks. While the application process is not as fast as swiping a card, a personal loan helps you avoid the high fees and higher interest rates associated with credit card debt. For borrowers on a tight timeline looking to make home renovations, a personal loan can be the perfect solution.

Personal loans don’t require equity in your home

Second, for those who bought a house recently and just paid closing costs, a personal loan may be your only option. As the name suggests, a home equity loan requires you to not just have good credit, but have equity in your home — which you won’t have until you’ve been paying your mortgage for some time.

In pre-financial crisis days, home equity loans were given out readily based on your home’s value. Since then, lending requirements have become more stringent. Most lenders require borrowers to have a stable income and a healthy credit report. Minimum credit score requirements vary by lender, but the higher your score, the better your chances are for approval.

Typically, you must have at least 15 to 20% equity in your property. Put another way, the loan-to-value ratio before the home equity loan needs to be below 85%. The lower your loan-to-value ratio, the greater the likelihood that you’ll be approved for a home equity loan. The loan-to-value ratio also determines the maximum amount you can borrow.

Generally speaking, your chances of qualifying for home equity loan or home equity lines of credit without having paid a significant chunk of your mortgage are slim.

Additionally, your debt-to-income ratio — your total monthly debt payments divided by your gross monthly income — is another important factor in determining whether or not you’ll qualify for a home equity loan. Most lenders prefer your debt-to-income ratio to be below 43%.

If you were planning to use your home equity for another expense

Lastly, a personal loan might be a better choice if you were planning to tap your home equity for something else. Some families rely on their home’s value to help pay for college education, while others might use a home equity loan to start a business or cover other liabilities. If this is the case, a personal loan could allow you to both make the necessary home improvements and leverage your home’s equity for another purpose.

When a home equity loan makes more sense

Home equity loans can be a good option for home improvements that will require between $25,000 and $60,000, as lenders typically won’t give you much more than that for an unsecured personal loan. If you’ve paid off a good amount of your mortgage and have excellent credit, however, you may be able to get a home equity loan for a larger amount of money.

In addition, secured loans tend to come with lower interest rates, and home equity loans typically hold a longer loan term than personal loans—translating to lower monthly payments. If you have significant equity in your home as well as the time and patience to wait for your application to be approved and the money delivered, a home equity loan may be a less expensive option over the life of the loan.

If you’re a member of a credit union, that may be a good place to start, as they may be able to offer you lower interest rates than a larger bank. You may also be able to save money and simplify your personal finances by using a home equity loan for debt consolidation, where you can combine multiple loans into a single monthly payment.

As with any loan, it’s always worth shopping around to compare your options — and in this case, it might be worth comparing not only within, but also across, loan types.

Home loan FAQs

When you’re on the hunt for a loan to spruce up your space, home equity and home improvement loans aren’t the only options. Here are some alternatives.

Is a home equity loan the same as a HELOC?

No. While home equity loans are often dispersed in a lump sum, a home equity line of credit (HELOC) works like a credit card. You’re able to borrow up to a maximum credit limit, which you can then draw as much or as little from as needed.

While you’ll be required to make a minimum monthly payment on the amount you withdraw, you also have the option to pay more than the minimum. Interest accrues on the outstanding balance. Like a home equity loan, a HELOC is secured by your home’s equity, so you’ll generally pay lower interest rates than you might with a credit card.

With a HELOC, you have a “draw period” during which you can make withdrawals from your credit line. Typically, the draw period lasts 10 years. Once the draw period ends, you enter a “repayment period,” a period of time during which you must pay back the loan and any accrued interest. HELOCs often have variable interest rates, which means they can fluctuate over the life of the loan. By contrast, most home equity loans come with fixed interest rates.

A key benefit of a HELOC is it offers flexibility in how much and when you can tap into the equity in your home.

Is a cash-out refinance a better alternative?

Home equity loans and HELOCs are essentially second mortgages on your home, while a cash-out refinance replaces your current mortgage with a new, larger loan. With a cash-out refinance, you’ll still have a single loan and payment. The difference is that, since you’re tapping into your home’s equity, the amount you’ll owe will actually increase.

A cash-out refinance may make sense if you’re using the loan for a specific purpose, such as home improvements or to pay off high-interest debt. Additionally, if you’re able to get a lower interest rate than your current mortgage, a cash-out refinance may be worth considering.

Is the interest on home improvement loans tax deductible?

A home equity loan is an unsecured personal loan, so generally that means you can’t take a tax deduction on any interest you paid. One exception is if you can prove to the IRS that you used the home improvement loan to upgrade your home for business purposes.

In some cases, you may be able to deduct a limited amount of home equity loan interest payments from your taxes. A tax professional can help you determine whether or not you can take any deductions.

Make room in your budget with Earnest

Home upgrades can be costly, so you may need to borrow money to cover the expense. A home equity loan is a second mortgage that lets you use the cash you’ve already invested in your home—your home equity—to guarantee the lender you’ll pay back the loan. On the other hand, a home improvement loan is a personal loan that’s unsecured, meaning the lender is taking on a lot more risk.

Generally speaking, home equity loans have lower interest rates and longer repayment terms than home improvement loans. You can usually borrow more with a home equity loan, too. For these reasons, a home equity loan may be better for larger home remodels, while a home improvement loan may be the way to go for smaller, lower-cost projects.

But these types of loans aren’t the only way to make room in your budget for a remodel. If you’re burdened by student loan debt, and you’re considering a refinance to potentially save thousands over the life of your loan, Earnest has you covered. With starting APRs as low as 3.74% for a fixed-rate loan and 2.49% for a variable rate loan (includes 0.25% Auto Pay discount1), refinancing your student loans with Earnest2 could lower your monthly payments and help you save thousands of dollars in interest over the life of your loan3. That’s extra money in your budget you could put toward creating the home of your dreams, one upgrade at a time.

Why not check your rate today? In only two minutes, our rate calculator can tell you if refinancing with Earnest could save you money, with no impact to your credit report.

This blog post provides personal finance educational information, and it is not intended to provide legal, financial, or tax advice.

¹ You can take advantage of the Auto Pay interest rate reduction by setting up and maintaining active and automatic ACH withdrawal of your loan payment from a checking or savings account. The interest rate reduction for Auto Pay will be available only while your loan is enrolled in Auto Pay. Interest rate incentives for utilizing Auto Pay may not be combined with certain private student loan repayment programs that also offer an interest rate reduction. For multi-party loans, only one party may enroll in Auto Pay.

Our lowest rates are only available for our most credit qualified borrowers and contain our .25% auto pay discount from a checking or savings account

² Loan Eligibility criteria: Your debt is from paying for education at a Title IV accredited school. The debt is from your education or your child’s. The debt you’re refinancing is for a completed degree or one that will be completed at the end of this semester. You are currently the primary borrower on the student loans you would like to refinance, and you will remain the primary borrower after refinancing. You must reside in the District of Columbia or one of the 48 states Earnest Operations LLC is authorized to lend in (all but Kentucky and Nevada). This is strictly a student loan refinance product. There is no opportunity to borrow more than your outstanding qualifying student loan amount. You must be the age of majority in your state or older at the time you apply, as well as be a United States citizen or Permanent Resident Alien without conditions. Refinancing is subject to credit qualifications. Please note, we are not able to offer variable rate loans in AK, IL, MN, NH, OH, TN, and TX.

³ You may lose benefits associated with your underlying federal and/or private loans if you refinance such as federal Income-driven Repayment Plans, Economic Hardship Deferment, Public Service Loan Forgiveness, or other deferment and forbearance options. If you file for bankruptcy, you may still be required to pay back this loan.