The truth is that no matter the residence, things tend to need improvements over time. Those cabinet doors had the hinges replaced a couple years ago, and they’re now in shambles. The kitchen floor was gorgeous back in 2015, but 2020 is another story. It’s to be expected; as homes age, they often need to be improved.
The kicker is the cash. It always comes down to cash, and we can’t say we’ve ever met the person or family that consistently deposits into their “future home improvement fund” monthly. Most of us don’t have such a fund, and if we did, it’s likely been raided for more interesting endeavors, such as a vacation or a new car.
Lenders recognize this, and that’s why home improvement loans exist. These are loans designed to promptly get you the cash to make home improvements and subsequently establish a repayment plan. In this post, we’ll explain the ins and outs of home improvement loans, the different types, whether they’re tax-deductible, and how your credit score comes into play. By the end, you’ll have all the information you need to make an informed decision on that home improvement you’ve been desperately waiting for.
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What is a Home Improvement Loan?
A home improvement loan is a loan from a financial entity to pay for improvement projects of any size. The amount of the loan can vary dramatically; there are loans anywhere from $1,000 (to address minor repairs) up to $50,000 or more (for things like new roofing or plumbing). The frequent repayment time frame of a home improvement loan is three to five years.
However, this is highly determinant on the type of loan you take out. If you fall behind on the monthly payments, like a credit card or auto loan, you’ll be hit with fees and penalties. The amount you end up qualifying for is also dependent on your credit history and your ability to repay.
The web is full of information surrounding financing home improvement projects with a credit card. The argument is it’s easier, principally because you don’t need to apply for a new loan – you already have the card. While this is true, most home improvement loans feature fixed rates and a lower APR (annual percentage rate) than your average credit card. So while merely financing that improvement project on your credit card might be quicker, you’ll likely pay more over the long-term as compared to a home improvement loan. The monthly payback will also vary with a credit card, much more than a home improvement loan.
Are Home Improvement Loans Tax Deductible?
The key to deducting a home improvement project’s costs lies in whether the improvement or repair adds value to your home. For example, if you seek to repair something and bring that something back to its original state, costs associated with that repair cannot be deducted.
A real-life example could be a leaky roof; your roof has been leaking for longer than you care to admit, but you haven’t had the cash on hand to repair it. You take out a home improvement loan, fix the roof, but this has essentially returned the roof to a working state. Hence, no improvement has occurred, it’s just a repair. Now, if you not only repaired the leak but also put on an entirely new roof, thus adding value to your home, those costs are tax-deductible.
The justification surrounding an improvement is that the IRS is interested in providing incentives to improve your property rather than merely maintaining it. Maintenance is a fact of life. We maintain our cars with regular oil changes, but maintenance returns the car to a working state – it doesn’t add any value to the car. An improvement to your property yields a positive impact for others. The next person to buy your home benefits from the improvement, and if the improvement is as visual as a new roof, for example, then your home makes the street block and the surrounding homes more attractive as well.
Some of the more popular home improvements that qualify for a tax deduction are new garage doors, a swimming pool, window and siding replacement, and the addition or modification of decks or porches. There is also considerable evidence demonstrating the value of these improvements and why the IRS allows for deductions. In the case of an improved garage, the average cost of such a project is $3,304, but the resale value associated with that new garage is $2,810. This means that the true cost of that improvement was only $494!
For some more helpful info on this topic, click here.
What Credit Score is Needed for a Home Improvement Loan?
Credit scores are like that pesky kid in the neighborhood, always in your business, showing up at inopportune moments, and sneezing into the bean dip. If you’ve got a good-to-great credit score, good for you. You’ve been diligent in repaying loans on time, and have probably worked at repairing your credit score. Most credit scoring systems occupy a scale starting at 300 and ending at 850. Some reach into the 950 level, but 850 is the standard.
For obvious reasons, a good-to-great credit score will open you to greater loan amounts and more favorable rates. If you’re seeking a HEL or HELOC (more on these to follow), then you’ll need a credit score of at least 660. However, that is still low, and most lenders are generally only interested in extending HELs and HELOCs to folks with 700 or higher. With that said, if you score 660 and are interested in a HEL or HELOC, it doesn’t hurt to apply.
Which Home Improvement Loan Should You Get?
We’ve now arrived at a decision – which loan to choose. There are a handful of home improvement loans to choose from, and all have their pros and cons. We’ll start with the personal loan.
The personal loan is an unsecured loan, as you won’t be using your home as collateral. Most personal loans feature fixed or adjustable rates, but a personal loan will typically carry a higher interest rate than some of the other loans we’ll touch on here. Payback with a personal loan is quite flexible, especially if you have decent credit. The application process is quick, the funds are available within 72 hours, making this an excellent option for emergency repairs.
Another home improvement loan to consider is a home equity loan (HEL). With a HEL, you can borrow against the equity you have in your home. To understand how much equity you’ve built up, simply take your home’s assessed value and subtract the balance you still owe on the loan. HELs are for folks who need funds for a large, one-time project. The loan amounts are typically substantial, and that’s why you’re borrowing against the equity you’ve built up.
If you don’t have a lot of equity, this might not be a good option. HELs carry lower rates because the collateral (your equity) that you’re putting up is valuable. The loan terms are 5 to 30 years with fixed interest rates. However, the major con that comes up with HELs is that many banks will charge origination fees plus closing costs.
Similar to a HEL is a HELOC (home equity line of credit). Think of this like a credit card where the lender pre-approves a fixed amount that you can pay back or even borrow from again. A HELOC makes sense if the improvements you’ll be working on are longer-term projects or will be on going for some time. There are no closing costs with a HELOC, and because the balance on the line of credit is revolving, you can re-use the funds after repaying them.
Something to watch out for, however, is the interest rates are adjustable. They can rise and fall over the duration of the loan. The lender also has the power to change the repayment terms at any time. Yet, the credit line is available in most cases for up to ten years, which is a nice cushion to count on.
To Sum it Up…
Pulling the trigger on a home improvement can be stressful. There’s likely 100 other things you’d rather be doing than contemplating a new roof. But if you go about this smartly and strategically, you’ll deduct the expenses on the improvement and end up with a home that’s jumped in value as a result of the improvement.
We covered what a home improvement loan is, how your credit score comes into play, the different types of loans and which ones are tax-deductible. A word of advice – consult with a trusted accountant before taking on a loan. Knowing whether the tax-deductible portion is clear is a must. The last thing you want to do is drop $40,000 and learn that you can’t deduct a cent. Home improvement loans can work to your advantage, but you need to put in some time to understand what you’re taking on and the tax implications.
Thinking about getting a head start on home remodeling this winter? Then check out Winter Home Improvement and Remodeling Ideas next!