Home Equity Vs. Home Improvement Loans

The value of a home is a concern for most homeowners, whether they plan on selling soon or staying in the home for a long time. If you're thinking about making improvements, you'll need to decide how to finance the cost. If you don't have enough cash in savings, a home equity loan or a home improvement loan can be used to pay for the improvements.

The equity in your home increases as you pay down the balance on the mortgage loan and as the home's value appreciates over time. You can borrow against the equity using a home equity loan. The basic type of home equity loan is a second mortgage taken out in addition to the existing loan. You get the funds from the loan as a lump sum to spend as needed. The general requirements for approval are similar to those of your first mortgage. You'll need a good credit score, enough income to support the new payments, and a low debt-to-income ratio. Home equity loans generally carry higher interest rates than first mortgages.

A home equity line of credit -- HELOC for short -- is similar to a home equity loan, but the money isn't disbursed in a lump sum. With a HELOC, you access funds as necessary during the draw period. You only use what you need and you'll only pay back what you've used. After the draw period ends, the repayment period begins, and you can no longer draw funds from the account.

Home improvement loans are offered by some lenders for the specific purpose of making home improvements, such as remodeling, an addition to the home or the installation of a swimming pool. These loans don't require collateral, so the equity in your home isn't taken into consideration. Generally, the lender will require you to provide a detailed plan of your projects. This may involve getting a quote and providing detailed drawings from a contractor. The repayment period typically is shorter than that of a home equity loan.

Deciding between a home equity loan and a home improvement loan ultimately depends on your financial situation, what you want to accomplish and plans for the future. A home equity loan can serve a variety of purposes in addition to making home improvements. Funds can be used to pay off high-interest debt, for example, for college tuition or for an emergency fund. If you haven't owned the home very long and need to borrow more money than you have in equity, the improvement loan would be a better option.