Home Improvement Loans 101: What They Are and How They Work

Whether you’re installing a new fence, replacing your roof, or upgrading your HVAC system, a home improvement loan can be a simple and effective way to finance the improvements you’re dreaming of.

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$5,000-100,000 Loan Amount

6.99-25.49% APR

2–12 years Terms

660 Minimum Credit Score

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How do home improvement loans work?

For the purposes of this discussion, a “home improvement loan” is a personal, unsecured loan you plan to use toward improvements or repairs to your home.

With an “unsecured” loan, you’re not using your home as collateral. This means if things go sideways and you find yourself unable to keep up with the payments, the lender cannot repossess your home.

The downside of an unsecured loan is that your interest rate will be higher. Putting up your home as collateral (in a “secured” loan) would lessen the risk a lender sees in you, and you’d be able to expect more favorable loan terms. 

Loan interest rates vary constantly, but Josh Shaw, Contractor Account Manager at Acorn Finance, says you can expect a difference of two to three percentage points between a secured and unsecured loan. “If you’re looking at a rate of 10% to 13% on an unsecured loan, you’re looking at 7% to 10% on a secured loan.” These two or three points can make a big difference over the payback period of your loan.

That payback period can vary widely for a personal loan, usually between one and seven years. A longer period will generally have smaller monthly payments but higher interest rates, meaning that by the time you’re done paying off the loan, you will have paid back a lot more money than you borrowed. 

Most people find that having smaller payments is attractive enough to opt for a longer payback period. As Rick Wilson, Director of Contractor Success at Acorn Finance, describes it, “The price often doesn’t matter. It’s the convenience.” But seek the terms that work best for you.

Where can you get a home improvement loan?

Tip

Personal loans are offered through a lot of financial institutions such as banks, credit unions, Acorn Finance and other online loan sources.

Personal loans are offered through a lot of financial institutions – brick-and-mortar as well as online. Let’s take a look at some popular places to find them.

Banks 

Most banks — national chains as well as smaller, local banks — offer personal loans, so there’s a good chance you can find a home improvement loan wherever you do your banking.

Some banks may only offer loans to account holders, and they may offer their customers very competitive terms. For example, as of October 2024, Wells Fargo offers home improvement loans to their customers at an annual percentage rate as low as 7.49%, which is on the low end of current rates.

Credit unions 

A credit union is a nonprofit financial institution. The main difference between a credit union and a bank is that a credit union is partly owned by its members (the people who use its services).

This member-run structure can result in more personalized service and lower interest rates. Mike McGinley, VP of Lender Relationships at Acorn Finance, says that “credit unions will try to do sort of special programs for their members,” like making personal loans available for members with low credit.

Acorn Finance and other online loan sources

A major advantage Acorn Finance has over banks or credit unions is the breadth of options available to you.

You’re not limited to what a single lender offers. You apply for a loan online by sharing your financial needs, and in seconds you’ll find a range of offers you’re pre-qualified for from a variety of lenders. 

Financial factors that affect your eligibility

There are several pieces of financial information that will determine whether you qualify for a personal loan. You’ll have to meet standards for income, credit score, and debt-to-income ratio.

Income

A lender will want to know you have a steady income to assess how able you are to pay the loan back. Income qualifications will vary from lender to lender, but make sure you have documents like pay stubs, tax records, bank statements, and other proof of employment, in case the lender asks for them.

Credit score 

The higher, the better. Credit scores run from 300 to 850. A high credit score signifies to the lender that you have a record of financial responsibility and successful debt payment. Shaw estimates that, as of Summer 2024, an excellent credit score (for example, 800 and up) could get you an interest rate of 13%, while a poor credit score (300 to 579) would get you 20%. Interest rates are always in flux, but that seven-percentage-point difference can be a good rule of thumb for illustrating the advantage of a good credit score for a personal loan. 

Debt-to-income ratio

Your debt-to-income ratio (DTI) is a measure of what percentage of your income goes toward paying your monthly debts.

“Monthly” is an important word to remember. Don’t factor in all of your credit card debt, or the entire amount of a mortgage or car loan you’re in the process of paying back. Your DTI should be based on your monthly payments toward those debts, as compared to the amount of income you receive per month. 

A DTI of 35% or less is ideal, and some lenders may be willing to go as high as 50%.

You can find instructions on calculating your DTI at the Consumer Financial Protection Bureau.

Important

You’ll have to meet standards for income, credit score, and debt-to-income ratio to qualify for a personal loan.

What to do when you’re ready to apply

The first step is to figure out how much your home improvement will cost. Many contractors offer free consultations and estimates, and you can consult multiple contractors to be as prepared as possible.

Then, with your income documents and DTI at hand, start comparing loan offers. (Acorn Finance lets you do this from your couch.)

Alternatives to home improvement loans

There are many ways to pay for a home improvement besides unsecured personal loans. Let’s explore how they compare.

Cash

It can be hard to imagine having tens (or hundreds) of thousands of dollars in cash on hand for a home improvement project. But if you’ve saved enough, cash can be a convenient option. There are no hoops to jump through for approval, no payment plans, and no interest you need to calculate. You pay, and you’re done.

Cash is also very convenient for the payee, so there may be a discount from the contractor.

The downside: Once you’ve paid, all that cash is gone, instantly, with none of it available for an emergency.

Credit cards

They’re convenient and readily available. “You can apply and be approved instantly,” Shaw observes. “You can start using them even before you get the card, in some cases.” 

With a good credit score, you can find a card with a 0% introductory annual percentage rate [APR] for the first year or two. If you can pay off the entire cost in that period, this can work out to an interest-free source of funding.

Once that introductory phase ends, Shaw says, “credit cards do come with higher APRs. They can go up to 35% for someone with a lower credit score, or with higher balances on their existing credit cards.”

And beware of deferred interest. Read the fine print; if deferred interest is part of the introductory rate, that means that if you haven’t paid off the entire debt by the end of that period, you’ll be on the hook for interest dating back to the entire purchase — even the portion you’ve already paid for.

Home equity options

These are secured loans: three financing options that use your home as collateral, allowing you access to a lower interest rate, but you’d be in danger of losing your home if you stop making payments.

If you’ve paid off around 20% of your home’s value, you can borrow against that equity by way of a home equity loan, a home equity line of credit (HELOC), or a cash-out refinance. All three result in a new mortgage, and all three have minimum credit score requirements of around 620.

• Home equity loans: Your funds arrive in a lump sum, which you pay back monthly as a second mortgage alongside your current one.
• Home equity line of credit: Instead of a lump sum, a HELOC is a revolving line of credit from which you can borrow and pay back as much or as little as you need. At some point, usually after ten years, the line of credit expires, and you begin paying back what you still owe as a second mortgage.
• Cash-out refinancing: Instead of a second mortgage, a cash-out refinance is a single, brand-new mortgage. It adds the amount you’re borrowing to the amount you still owe on your home, and you pay this new mortgage down with a single monthly payment.

Consider a personal loan from Acorn Finance

As mentioned, Acorn Finance can streamline your search for a home improvement loan, with loan amounts ranging from $1,000 to $100,000. Enter your funding needs into a simple, online interface, and almost instantly you will see a selection of personal loans you’re pre-qualified for. You can sort your selections by what is most important to you, whether it’s interest rate, monthly payment amount, or term length. 

Your search can take place from your phone or laptop. You can sit in your home and fantasize about the improvements you want to make while scrolling through the offers that can help you start.