With housing prices remaining high and mortgage rates on the uptick, many homeowners are opting to renovate their existing homes rather than purchase a new property. And to fund these renovations they are increasingly turning to home equity – tapping into their ownership stake to generate funds. I wanted to provide a comprehensive guide examining how to utilize home equity to finance home improvements.
There are two primary options for leveraging your home equity
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Home Equity Loans – These function similarly to mortgages, You borrow a lump sum at a fixed interest rate and make scheduled repayments covering both interest and principal over 5 to 30 years,
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Home Equity Lines of Credit (HELOCs) – HELOCs provide you with a line of credit and variable interest rate. You can access funds over a 10 year “draw period”, making interest-only payments. Then you enter a 10-20 year “repayment period”, paying back the principal plus interest.
In both cases, the max you can borrow depends on your equity and loan-to-value ratio (LTV). Typically lenders will let you leverage around 80-85% of your equity.
Why Tapping Home Equity for Remodeling Makes Sense
With home values up significantly, the average homeowner now has around $300,000 in equity. Tapping a portion of that can be prudent to fund renovations. Here’s why:
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Lower Interest Rates – Home equity loans and HELOCs offer lower rates than alternatives like credit cards or personal loans. Rates are closer to mortgage rates.
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Tax Benefits – You may be able to deduct interest paid on home equity loans/HELOCs. Certain conditions apply, such as using funds for home improvements.
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Return on Investment – Upgrading and remodeling projects can boost your home’s value. Investing your equity to improve the property can pay off if you eventually sell.
The Pros and Cons of Using Home Equity Financing
While leveraging your equity can make good financial sense, it also carries risks. Let’s examine some key pros and cons:
Pros
- Entry point to low interest rate funds
- Interest may be tax deductible
- Renovations can increase property value
- HELOCs offer flexible access to funds
Cons
- Risk of foreclosure if payments are missed
- Loan amount may exceed what you need
- Closing costs/fees associated with home equity loans
- HELOCs have variable rates that can rise
Home Equity Loans vs HELOCs: Key Differences
When deciding whether to utilize a home equity loan or HELOC, consider:
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Home Equity Loans – Better if you know renovation costs upfront. Offer predictable payments. However, provide funds in a lump sum which can be tempting to divert.
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HELOCs – Ideal for uncertain or evolving projects. Lower risk of over/under borrowing. But variable rates mean costs can rise over time.
What’s the Max You Can Borrow?
The max home equity loan or HELOC amount you can qualify for depends on:
- Your total equity
- LTV limits set by the lender (usually 80-85% LTV)
- Other factors like income, credit score, and DTI ratio
Use an online calculator to estimate potential loan amount.
Tips for Using Home Equity Financing Responsibly
If you utilize a home equity loan or HELOC for remodeling, here are some tips:
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Shop around for the best rates and fees – Don’t just go with your existing lender.
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Get quotes from multiple contractors – Confirm you’ll have adequate funds before starting work.
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Create a repayment plan – Factor loan payments into your budget to ensure you can afford them.
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Pay off high interest debt first – If you have extra funds, pay these balances before finishing lower priority projects.
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Ask about early repayment options – Look for flexibility to repay faster and reduce interest costs.
Alternatives to Home Equity Financing
Other options beyond HELOCs and home equity loans include:
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Cash-out mortgage refinance – Secures a new mortgage exceeding your current balance, providing the difference in cash.
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401k/Retirement account loans – Allow you to borrow against your own savings then repay over 5 years.
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Low-interest credit cards – Can make sense if you have excellent credit and can pay off during an intro 0% APR period.
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Personal loans – Offer quicker access to funds than home equity options, but have higher rates and shorter terms.
Carefully weigh the pros, cons, costs, and risks when deciding how to fund your next remodeling project. While tapping home equity is a common choice, make sure it aligns with your financial situation and goals.
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How to use your home equity to finance home improvements June 20, 2020
There are three main ways to tap into the equity you’ve built in your home. Each has its advantages and disadvantages.
Whether you want to remodel your entire home or just upgrade the kitchen, funding your project is a key step in the process. Not sure what project to tackle first? We can help you choose the project that will get you the most bang for your buck. Once youve chosen your project using your home’s equity may be the best way for you to get it done.
Banks typically lend up to 90 percent of the equity value you’ve built in your home. So, for example, if you have $150,000 in home equity, you may be able to borrow up to $135,000, using your home as collateral.
Work with your bank to determine how much of your home equity you can tap into because lender amounts, rates and terms will vary. Whatever amount you borrow, you can use the loan to fund your projects: roof upgrade, new patio deck, interior renovations, etc. Whenever you take out a loan, it is smart to be clear on stipulations in the agreement about how you can use the funds.
Three ways to borrow on your equity
Each method has advantages and disadvantages. You should determine what option best fits your situation.
1. A home equity loan
Also known as a second mortgage, these loans allow you to borrow a set amount of money for your project. You will be given a fixed interest rate and be expected to make monthly payments commencing immediately upon taking out the loan.
May be right for you: If you have a major renovation for which you’ll need a substantial amount upfront, and you’re looking for a competitive, fixed interest rate.
2. A home equity line of credit (HELOC)
A HELOC allows you access to a line of credit. You can use as much of the money available, whenever and however you choose over a fixed period, often 10 years.
Repayment is based on the terms of your HELOC but is much more flexible than a home equity loan. While you need to make only minimum monthly payments, the final amount that you borrow will have to be repaid at the end of the agreement. These loans are offered with a range of variable interest rates.
May be right for you: If you’re doing several smaller projects that require incremental funding, or you won’t be sure how much you need to spend until you’re halfway through.
3. Home refinancing
Getting funding through a home refinance involves updating your current home mortgage, adjusting the interest rates or terms of the loan and taking out cash at the same time. You’ll be reducing the equity you have in your home. Home refinancing can reduce your monthly mortgage payment if you extend the term of your repayment schedule.
May be right for you: If your credit has improved or interest rates have gone down since you took out the original mortgage, you’ll want to capture a lower interest rate on your mortgage as a whole.
May be right for you: You may also be able to get a lump sum without increasing your monthly payments if you extend the length of the loan. This can make a project far more affordable in the short term.
Should you take out a loan of some sort?
When contemplating your financing options, review first how much is available for you to borrow. And then think about how much you can actually afford. Remember that loan originations involve fees and costs, so factor those into your calculation. And consider the long-term effect of having (likely) higher monthly financial obligations. Are you comfortable with this?
If, after serious consideration, you’re still ready — and your project will be well within this budget — it might be time to talk to a lender about how to use your home equity.
Learn more about home equity options.
What is the Best Way to Pay for Home Improvements?
FAQ
Is a home equity loan a good idea for home improvements?
What is the monthly payment on a $50,000 home equity loan?
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Loan amount
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Monthly payment
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$25,000
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$166.16
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$50,000
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$332.32
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$100,000
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$673.72
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$150,000
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$996.95
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What is the downside of a home equity loan?
What disqualifies you from getting a home equity loan?
Can a home equity loan finance a remodeling project?
There are numerous ways to finance your home remodeling project and home equity loans are a great way to do so. Home equity loans are repaid in fixed monthly payments, tend to have lower interest rates and longer repayment periods and are a great way to fund a home improvement project that can build your equity.
How can I use my home equity to finance home improvements?
You can use your home equity to finance home improvements in several ways.One option is to take out a **home equity loan**.This type of loan allows you to borrow a lump sum at a fixed rate with a payback
Are home equity loans a good idea for renovations?
Home equity loans can be a good idea for renovations because they offer low interest rates, the interest can be tax deductible, and the renovations may increase your home equity. However, a home equity loan isn’t right for everyone, so it’s important to weigh the pros and cons.
Are home equity loans a good idea?
Home equity loans have generally low interest rates and can be used for any purpose. As an added bonus, you may even be able to deduct the interest on your loan, depending on the home improvement project.