Which Loan Is Best for Home Renovations: Personal, Credit Card or Home Equity?

If you're eager to put in a new bathroom, replace your battered hardwood living room floor or build an addition on the back of your house so that your kids can have their own bedrooms, you're not alone. Americans spend more than $400 billion a year on renovating and repairing their houses, according to the Joint Center for Housing Studies at Harvard University.

But after you've figured out what you want to do, found the right contractor, and negotiated a price, the big question is: How do you come up with the bucks to pay for the upgrades or repairs that you want to do, if you haven't saved up the cash?

One option is using a personal loan — an installment loan, usually unsecured, from a bank or another financial institution, which can be used for almost any purpose you choose. According to research by LendingTree, an online loan marketplace, 7.7 percent of the consumers who obtained personal loans through the website in 2018 used them to make home improvements. The average loan was $12,384.

But is a personal loan the best choice for fixing up your house? Experts say that can depend upon a number of factors, including the type of renovation and the anticipated cost.

According to Consumer Reports, there are several other good options for financing home improvements:

A home equity loan. This is a second mortgage on your home, which gives you a lump sum to work with.
A home equity line of credit, also known as a HELOC. It's essentially a credit card backed by your home as collateral, which allows you to charge payments for one or more renovation projects as you need the money.
A contractor loan. The company doing your renovations may offer to provide you with a loan, through a third party such as a finance company.
Charge it on a credit card. If you've got excellent credit, the limit on your card may be $11,000 or higher, according to The Balance. That might be enough to pay for a small renovation project. Some homeowners put renovations on a new card with zero percent introductory rate, which gives them an opportunity to pay off much or all of the balance before the principal starts accumulating interest charges.

Interest Rate Is Key

One crucial factor to consider is the interest charge for each type of loan. Because home equity loans and HELOCs are secured by your home, they're most likely going to have lower interest rates than an unsecured personal loan.

For home equity loans, for example, LendingTree listed an average annual percentage rate (APR) of 4.94 percent for a $25,000 loan, as of February 2020. For $50,000 loans, the APR dropped to 4.69 percent, and for $100,000 or more, it was just 3.74 percent.

In comparison, personal loan rates vary from 6 to 36 percent, with an average rate of 9.41 percent, according to Experian, one of the nation's three major credit reporting companies. (This data was for Q2 2019.)

"Personal loans are almost never good candidates for purchases that could be financed with secured debt," explains Matthew Frankel. He's an investment advisor and certified financial planner based in Columbia, South Carolina, and author of this guide to the best current personal loan rates for personal finance website The Ascent.

Rod Griffin, Experian's director of public education, says in an email that personal loans are suitable mostly for relatively small, inexpensive home improvements.

For instance, if you just want a few thousand dollars to replace the toilet and shower and put in some ceramic tile, a personal loan might be a good way to come up with the money, while avoiding the closing fees that come with a home equity loan or a HELOC. (With a home equity loan, for example, those charges can add anywhere from 2 to 5 percent to the amount you're borrowing, according to LendingTree.)

Home Equity and HELOC Loans

But for a more expensive job, you'll save a huge amount of money on interest if you take out a home equity loan. "If you're doing a full renovation, there are other financial tools that are better suited for big-ticket purchases," Griffin says.

But home equity loans and HELOCs may not necessarily be an option for every homeowner. "For a lot of people, those would be the better choice, as long as they have enough equity built into their homes," explains LendingTree research manager Kali McFadden. However, "slipping below 20 percent of equity means they would be required to take on personal mortgage insurance, which is another monthly payment, and people with very low equity would not be able to get a home equity loan or line of credit."

Credit Cards

What about a new credit card with a zero-interest introductory rate? That would be even cheaper than a personal loan — provided that you can pay off the loan in the introductory period, which typically lasts 12 to 18 months, though some cards offer even longer breaks, according to Experian. After that, the card's standard APR kicks in. Right now , the average credit card APR is 17 percent, according to Griffin. That's nearly twice the interest rate that a personal loan would cost you.

A personal loan also has another significant advantage over home equity and HELOCs for home renovations, in that you may be able to get the money quickly if you use an online lender that employs financial technology, also known as FinTech, to automate and speed up the loan approval process. That can come in handy if you've got an emergency repair to make, such as fixing a badly leaking roof.

"Unfortunately, some individuals don't have savings available," emails Dwain Phelps, founder and CEO of Phelps Financial Group in Kennesaw, Georgia, who works with his own clients to set up "saving to spend" accounts to cover such emergencies. For the unprepared homeowner, though, "a personal loan could help with those major unexpected expenses."