For most Canadians, a home will be the single most valuable asset they ever own so it’s crucial to maintain it to ensure it holds its value over the long term. However, while many homeowners would welcome the chance to renovate, the costs associated with upgrades can be substantial, making it challenging for many to finance a home improvement project.
That’s where home improvement loans come in. The right home improvement loan allows you to make desired upgrades while maintaining a manageable debt load that you can pay off in a reasonable amount of time. This article will discuss the various types of home improvement loan options available, the pros and cons of each and how to choose the best loan for your needs.
What Is A Home Improvement Loan?
There are numerous types of home improvement loans, but in general, they are intended for repairs or upgrades on your property to improve or maintain its overall value. They can be for amounts as small as $500 up to $50,000 or more, depending on the size of the improvements you’re looking to make.
Possible uses for a home improvement loan include things like increasing your living space with an addition, redoing a bathroom, building a basement suite, getting a new kitchen or upgrading your plumbing or electrical wiring.
Can You Roll Your Home Improvement Costs Into Your Mortgage?
According to a CMHC study, 38% of mortgage consumers didn’t know you could roll your home renovation costs into their mortgage. In Canada, you can use a Purchase Plus Improvements (PPI) mortgage to get a lump sum of money that covers your home purchase and renovation costs. These loans are generally available with most big banks and lenders.
Can You Use CMHC Improvement To Help Get The Financing You Need To Renovate?
CMHC Improvement is available to homebuyers looking to buy a new construction or an existing home that requires renovations.
With CMHC Improvement, you can obtain insured financing for 95% of the “as-improved” value for owner-occupied homes with one to two units. As-improved value refers to the market value of the property after improvements.
For homes that need improvements, CMHC Improvements offers homebuyers a choice of flexible advancing options. This makes it easier for homebuyers to access funds needed for immediate improvements to the home.
Single Advances
This option is available for improvements that costs 10% of the as-improved value or less.
For example, say you need to repair the kitchen before you can move into your home. The original price of the home is $200,000 and the price once the renovations are done would increase the value to $225,000. Ten percent of the as-improved price is $22,500, so you could borrow $247,500. This amount will not only cover your mortgage but the spare money will be used to complete the required home improvement project. Once you take out the extra money, the balance will be owed in the form of a monthly mortgage.
Progress Advances
- Basic Service involves lenders validating advances without requiring pre-approval from CMHC.
- Full Service involves CMHC validating advances for up to four consecutive advances at zero cost.
| What is As-Improved Value? The as-improved value is equal to the market value of the property after improvements. |
Eligibility Requirements For CMHC Improvement
There are many restrictions on who can use the CMHC Improvement program. To be eligible for the CMHC Improvement program, you must:
- Be a Canadian citizen or permanent resident
- Have an LTV ratio of 95%
- Provide a down payment of 5% of the first $500,000 of the lending value and 10% of the remainder of the lending value.
- The home purchase price must be less than $1,000,000
- The maximum amortization period must be 25 years
Note: These requirements are for owner-occupied homes (1-2 units). Additional requirements may apply.
| What is the lending value? The lending value is equal to the lesser of: The as-improved value, orThe as-is value (current market value of the property) plus the cost of improvements |
Other Types Of Home Improvement Loans
While CMHC Improvement can help you access more financing options, there are plenty of other options to choose from.
Unsecured Personal Loans
Personal loans are a popular option for financing smaller home improvements. This can be ideal if you don’t have a lot of equity built up in your home and therefore can’t use it as collateral to get better rates (loans with collateral usually offer better rates and terms).
Lenders will determine your creditworthiness by looking at factors such as your credit score, income and debt-to-income ratio. There are a lot of personal loan providers in Canada and the interest rates they offer can range from reasonable to break-the-bank, so doing your research is essential if you want to find a reasonable and trustworthy lender.
Pros
- With no collateral considerations (like getting your home’s value appraised), you’ll generally have a quick and easy application process. Often you can look for the best loans online and choose from numerous offers via online loan platforms.
- There are loan options available for those with a history of bad credit.
- No risk of losing your home if you default on the loan.
Cons
- Unsecured personal loans tend to come with higher interest rates compared to secured loans like home equity loans or home equity lines of credit (HELOCs).
- Shorter repayment terms, typically ranging from 6 to 60 months in Canada.
- Lower loan amounts compared to secured loans.
Home Equity Loans
A home equity loan, sometimes called a second or add-on mortgage, is a type of loan used by homeowners who already have a mortgage. It allows property owners to borrow money using the equity they’ve accumulated in their home as collateral.
The equity in your home is essentially the difference between the current market value of your property and the balance remaining on your mortgage. With a home equity loan, you receive a lump sum of money that you’ll repay with set payments. Usually, you can borrow up to 80% of your home’s equity (minus any balance owing) and your rates can be variable or fixed, which gives you flexibility.
Pros
- Lower interest rates compared to unsecured personal loans and credit cards (though home equity loans typically have higher interest rates than your first mortgage).
- Longer repayment terms than with a personal loan.
- Homeowners can borrow larger amounts depending on their available equity.
Cons
- You could lose your home if you default on the loan.
- As with a first mortgage, there can be appraisal fees and costs with a home equity loan.
- Reduces the available equity in the home.
- Fixed loan amount and less flexibility compared to a HELOC.
Home Equity Lines of Credit (HELOC)
A Home Equity Line of Credit, or HELOC, is a revolving line of credit with a borrowing amount tied to the equity in your home. Unlike a home equity loan, which provides a lump sum, with a HELOC you can make withdrawals as needed up to a predetermined credit limit and you only pay interest on the amount you borrow.
There’s also no pre-set payment schedule. You just have to make monthly minimum payments on the amount you’ve borrowed and you can pay back any amount you withdraw at any time without paying a penalty fee.
Pros
- Flexibility to borrow funds as needed; take out as little or as much as you want on your own schedule.
- HELOCs usually have lower interest rates than personal loans or credit cards and you only pay tax on what you borrow, which can help keep interest costs down.
- Unlike with a personal loan, there is no pre-set payment schedule.
Cons
- Interest rates are typically tied to the bank’s prime rate, so it can fluctuate often.
- Such easy access to a large chunk of funds can lead to overspending if not careful.
- Your home is at risk if you default on payments.
- There are usually some costs (like appraisal and legal fees) associated with setting up a HELOC.
Mortgage Refinancing
If you’re carrying a mortgage on your home, another option to access funds for home improvement fixes is to refinance your current mortgage. When refinancing to fund home renovations, you essentially borrow more than your current mortgage balance, and the extra money is used to pay for the improvements. You can usually borrow up to 80% of your home’s equity. Mortgage refinancing may also allow you to take advantage of lower interest rates, depending on current market conditions.
Pros
- Potentially lower interest rates compared to other options like a personal loan.
- You can spread renovation costs over the amortization period of the mortgage.
- Opportunity to take advantage of lower interest rates and, if desired, switch from an adjustable-rate to a fixed-rate mortgage.
Cons
- Refinancing involves fees such as getting a home appraisal and legal fees.
- If you extend your mortgage term when refinancing, you’ll end up paying more interest over time.
- You risk losing your home if you default on the new mortgage payments.
How To Choose The Right Home Improvement Loan
Here are some factors to consider when deciding what home improvement loan works best for your needs.
- Interest rates. Getting the lowest interest rates possible could save you tens of thousands of dollars throughout your loan. However, the rates you’ll be offered are often tied to your creditworthiness so it’s wise to do what you can to get your score as high as possible before you apply. Be sure to take the time to compare rates from a variety of lenders to find the most cost-effective option.
- Loan terms. Consider how long you want to be locked into a contract and weigh the pros and cons of variable versus fixed rates. Fixed rates give you stability but could lead to higher overall payments over time.
- Fees and penalties. Be sure that you fully understand all the fees associated with your home improvement loans and ask about prepayment penalties if you want to pay off your loan early.
General Eligibility Criteria For A Home Improvement Loan
As with any type of loan, there are eligibility requirements that you’ll have to meet to qualify for a home improvement loan successfully. Requirements will depend on the potential lender and your unique circumstances, but here are some general guidelines:
- You’ll typically need to have accrued 15% to 20% of your home’s value in equity for equity-based loans.
- Have a good credit score of approximately 660 or higher. The higher the score the better. The credit score needed will also depend on whether or not you’re providing collateral.
- You’ll usually need to be employed with a stable source of income.
- Lenders vary on their requirements but some want to see a debt-to-income ratio percentage (DTI) as low as 35% of your gross monthly income, though some may accept a DTI as high as 44% or more.
The more attractive you can make yourself as a loan candidate by improving your credit score and reducing your debt load, the better chance you’ll have of getting a home improvement loan with favourable terms and a lower interest rate.
How To Apply For A Home Improvement Loan
Here are some general guidelines about how to apply for a home improvement loan.
- Research. This can be the most crucial step. Don’t rush but rather take your time to research all the possible lending options available to you. Check what rates and terms you might be eligible for by searching online loan platforms and speaking to your bank.
- Credit Scores. Credit scores are key determinants in getting good lending rates so check your score to ensure your score is healthy. If there’s room for improvement, consider holding off on applying for a loan until you’ve increased your score.
- Gather your documents. You’ll need things like proof of employment, bank account info, tax returns and valid ID to apply for the loan.
- Home Improvement Credits – Investigate whether you might be eligible for some home improvement tax credits, grants or loans. There are some territorial and provincial programs available to qualified homeowners that could help save you thousands of dollars.
