November 28, 2023

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Home improvement projects can increase the value of your home and make your space more livable. Unfortunately, they are often expensive and many people need to borrow in order to make big changes to their properties.

If you are financing home improvements via debt instead of paying for them out of savings, it’s important to choose the right type of loan. You have several options, including securing a personal loan or taking out a second mortgage or cash-out refi loan on your property.

While many people default to taking out a home loan since they’re using the funds to improve their house, personal loans can actually be a good alternative source of financing in some circumstances. To help you decide if a personal loan or a mortgage is the best choice for you, consider these pros and cons.

Pros of paying for home improvements with a personal loan

Here are some of the biggest advantages of using a personal loan to pay for home improvements.

  • It can be faster and easier to get approved: Mortgage loans — including second mortgages and cash out refis — can sometimes have a lengthy approval process. It can take weeks, and require a lot of financial paperwork, before a loan is approved and money is made available. There may also be lots of hurdles to jump through, including getting a home appraised. Personal loans, on the other hand, have a simpler application process and funding can often be made available quickly — sometimes, as soon as a few days after applying.
  • The debt is unsecured so your house isn’t on the line: Many personal loans are unsecured debt, which means there is no collateral guaranteeing the loan. By contrast, mortgage loans are secured debt and the house guarantees the loan. As a result, if you become unable to repay it, you could lose your property.
  • You’ll avoid closing costs: Securing a cash out refi or a first or second mortgage loan can require you to pay thousands of dollars in upfront closing costs. You may need to pay a mortgage origination fee, title insurance costs, and appraisal fees — among other expenses. By contrast, many personal loans have low or no application fees so you don’t need to come up with thousands of dollars just to be able to borrow.

Cons of paying for home improvements with a personal loan

There are also some downsides of opting for a personal loan, rather than taking out some type of mortgage loan when you’re improving your property. Here are three of them.

  • Your interest rate will likely be higher: Since personal loans are typically unsecured debt, they are riskier for lenders than secured mortgages. As a result, they may have a much higher interest rate. Mortgages are typically one of the single most affordable ways to borrow.
  • Your monthly payment may be higher: Personal loans may have a shorter repayment period and a higher rate than mortgage loans. As a result, your monthly payment could be higher with a personal loan used to finance home improvements than with a mortgage. This could put more strain on your budget.
  • You won’t be able to deduct interest on your taxes: Mortgage interest — including on second mortgages — is typically tax deductible if you itemize (especially if the funds are used to pay for home upgrades). If you can deduct interest costs, the government subsidizes your borrowing. By contrast, interest isn’t deductible on personal loans, so you don’t get this borrowing benefit.

So, which approach is right for you? Ultimately, it depends on your goals, the type of personal loan or mortgage you can qualify for, the amount you’re borrowing, and your payoff timeline. You should carefully consider each option to decide which makes the most sense for your situation in light of both the advantages and disadvantages of each financing method.

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