Increase Your Home Equity with Smart Renovations

Brandon Segal was set to make a substantial addition to his historic house in a Philadelphia suburb, but he wasn’t sure how to pay for it.

He didn’t have enough equity to cover the six-figure renovation bill with a home equity line of credit or a cash-out refinance. A construction loan struck Segal as complicated and cumbersome.

Segal settled on a home equity loan through RenoFi, a financial technology company that connects homeowners with credit unions willing to loan based on how much a house will be worth after upgrades are completed.

“I like the ability to borrow based on what my appraised value is going to be,” Segal said.

RenoFi served as a matchmaker, directing Segal to Ardent Credit Union, a Philadelphia lender. He took a 20-year, fixed-rate loan to pay for a two-story addition to his 1920s home.

Renovating your home can be an exciting endeavor, allowing you to update worn or outdated features and make the space truly your own. However not all renovations boost your home’s value equally. If you are planning renovations to increase your home equity in order to qualify for a home equity loan or line of credit choosing the right projects is key.

How Home Renovations Can Increase Home Equity

Home equity is the difference between what you owe on your mortgage and the current market value of your home. Taking out a home equity loan or line of credit allows you to borrow against that equity.

Renovations and upgrades have the potential to increase your home’s value, thus raising your equity and allowing you to qualify for more favorable loan terms. However, some renovations provide a much better return on investment than others.

According to Remodeling Magazine’s 2021 Cost vs. Value report, the renovations with the highest average ROI nationwide are:

Garage door replacement (93.8% recovered)
Manufactured stone veneer (92.1% recovered)
Minor kitchen remodel (72.2% recovered)
Fiber cement siding replacement (69.4% recovered)
Vinyl window replacement (68.6% recovered)

Meanwhile, a survey by the National Association of Realtors and National Association of the Remodeling Industry found these interior projects have the highest ROI:

Hardwood floor refinishing (147% recovered)
New wood flooring (118% recovered)
Insulation upgrades (100% recovered)
Basement conversions (86% recovered)
Closet renovations (83% recovered)

For exterior renovations, painting or staining your home’s siding can provide great bang for your buck, with high homeowner satisfaction and widespread buyer appeal.

Choosing the Right Renovations

Not all upgrades are created equal when it comes to boosting home equity. As a general rule, renovations that update worn, damaged, or out-of-date features will fare better than luxury upgrades.

Buyers also tend to prefer renovations that add living space or functionality, rather than flashy features like pools and spas. Focus on renovations that will appeal to the widest range of buyers

Here are some dos and don’ts when choosing renovations with home equity in mind

DO

Update your kitchen and bathrooms
Refresh flooring and paint
Replace worn roofing, siding, windows, and doors
Improve insulation and HVAC systems
Finish basements and attics
Build an accessory dwelling unit (ADU)

DON’T

Install a pool or hot tub
Splurge on high-end finishes like marble and hardwood
Convert garages to living space
Over-renovate for the neighborhood

Calculating Your After Renovation Home Value

When applying for a home equity loan or line of credit, lenders will require an appraisal to determine your home’s value after proposed renovations. This is called the “after renovation value” or ARV.

The appraiser will consider:

Your home’s current value
Local market conditions
Recent neighborhood sales
Your renovation plans and budget
Estimated costs for materials and labor

They will analyze the impact of your renovations and provide an ARV that factors in about 70% of your total renovation investment. This allows room for some ROI deterioration over time.

You can estimate your potential ARV using this formula:

Current home value + (70% of total renovation costs) = Estimated after renovation value

However, the appraiser’s official ARV is what matters for loan qualification. Work with your lender and provide as much detail as possible to ensure the appraiser can accurately assess the value boost from your renovations.

Financing Your Renovations

Once you’ve identified equity-boosting renovations and calculated your estimated ARV, it’s time to choose the right financing. Here are two top options for funding renovations using your home equity:

Home Equity Loan

This provides a lump sum based on your home equity, which you repay over a fixed term with fixed interest. Pros include predictable payments, flexible spending, and often lower rates than other financing options.

Home Equity Line of Credit (HELOC)

This acts like a credit card, allowing you to draw against your available equity as needed. You only repay interest on what you use. It’s ideal for ongoing or unexpected renovations.

Look for lenders like RenoFi that offer HELOCs and home equity loans based on your ARV, not just your current equity. This provides more funds for renovations.

Maximizing Your Home Equity

With strategic planning, you can choose renovations that maximize your home’s future value while staying within your budget. Follow these tips:

Research values in your local market. A pool might boost equity in Florida but not Minnesota.
Talk to real estate agents about buyer appeal. Curb appeal matters.
Read up on national cost vs. value reports. Minor kitchen updates often fare better than elaborate remodels.
Focus on renovations that fix existing issues first. Update layouts and finishes second. Luxury touches come last.
Submit detailed renovation plans and contracts to your lender to ensure the most accurate ARV.
Consider DIY projects when possible. Sweat equity pays off.
Work with a reputable contractor and secure all required permits.
Stick to your budget and timeline. Delayed or over-budget projects can

How the loans work

RenoFi loans are second mortgages. In one example, Ardent Credit Union offers 20-year loans at a fixed rate of 4.25%, Goldman said. That’s higher than the rate on a primary mortgage, but it includes the flexibility of allowing homeowners to borrow against yet-to-be-created value.

Borrowers pay for an appraisal that establishes the home’s value after renovation. The appraiser looks at the proposed construction plan and determines by how much the work will boost the property’s market value.

The typical RenoFi customer borrows $150,000, Goldman said. At that amount, a 20-year loan with a 4.25% interest rate carries a monthly payment of $929.

Goldman said RenoFi’s loans also appeal to homeowners who recently locked in loans at rock-bottom levels and don’t want to do a cash-out refinance to pay for improvements.

“If you’ve taken advantage of a low rate and refinanced, you’re going to have to pay all those closing costs again,” Goldman said.

That situation applied to Segal, the Philadelphia-area homeowner. He had recently refinanced and didn’t want to do so again.

“We have a great rate on our current mortgage, and we didn’t want to touch that,” he said.

To land a RenoFi loan, the borrower pays for the after-renovation appraisal, which typically costs $100 to $200 more than a standard appraisal, Goldman said. Beyond that, closing costs typically range between $95 and $500.

“Credit unions’ closing costs are typically lower than a traditional bank, so in the end, it’s still cheaper for the homeowner,” Goldman said.

Pandemic spurs improvement boom

The coronavirus pandemic has turned home improvement into a national pastime. In one illustration of that trend, the National Association of Home Builders’ remodeling index soared during the pandemic. Home-improvement retailers and remodeling contractors reported spikes in business.

With many Americans working from their home offices, more homeowners have developed a hankering for upgrades to their spaces. Meanwhile, a spike in home prices and a shortage of homes for sale limits the choices available to those who’d traditionally be move-up buyers.

The national median price of homes sold by Realtors spiked 12.9% from December 2019 to December 2020. Housing inventory fell to a record low, according to the National Association of Realtors.

Segal, for his part, loves the house he shares with his wife and their three daughters, but the quarters were getting cramped. He found a contractor to add a master bedroom and other living space to the house.

Paying for home improvements can pose a challenge, however. A home equity line of credit, or HELOC, is one tried-and-true source of renovation funds.

But HELOCs work only for homeowners with significant equity. If you owe $300,000 on your $400,000 property, a bank is unlikely to lend $100,000 through a HELOC. To keep your loan-to-equity level at 80%, or $320,000, you’d be able to borrow just $20,000.

RenoFi offers a different approach: Homeowners can borrow up to 90% of their home’s after-renovation value.

The company has partnered with credit unions throughout the country to offer the loans, said Justin Goldman, founder and chief executive of RenoFi. Goldman launched the company after experiencing firsthand the challenges of paying for renovations on an older home.

He created RenoFi to fill what he sees as a gap in the market. Goldman found most lenders didn’t offer after-renovation loans, so he began persuading credit unions to add RenoFi home equity loans to their offerings.

Should I Borrow To Renovate? Home Improvement Loan or Home Equity Line of Credit?

FAQ

How is value determined for home equity loan?

When you apply for a home equity loan or line of credit, an appraisal of the value of your home’s worth will be done. The appraisal will examine the size of your home, number of bedrooms and bathrooms, property location, surrounding area and other factors to determine your home’s current market value.

What is the 30 percent rule for home renovation?

Home renovation is a huge undertaking, and almost invariably takes more time and costs more money than homeowners expect. Rasekh says it’s a good idea to set 20 to 30 percent of the total cost of your project aside for the unexpected — that’s up to 30 percent on top of the project’s original cost estimate.

Is equity based on appraised value?

You can figure out how much equity you have in your home by subtracting the amount you owe on all loans secured by your house from its appraised value. This includes your primary mortgage as well as any home equity loans or unpaid balances on home equity lines of credit.

Does remodeling increase equity?

Increase the value of your home: Some renovation projects will likely increase your home’s value, which in turn, will increase, over time, your equity and may mean a higher sale price when you are ready to sell.

Should I use a home equity loan for renovations?

If using a home equity loan for renovations is not the right choice for your financial situation, fear not. There are numerous other home improvement loans and financing options available. A cash-out refinance is a type of mortgage refinance where you can use some of the equity you’ve built in exchange for cash.

Should I refinance my home’s equity for remodeling?

If you’re considering using your home’s equity for remodeling, be cautious about refinancing, as it could mean losing your current favorable interest rate on the primary mortgage. A construction loan is a specialized type of loan designed to finance the construction or renovation of a property.

Should you use home equity for home improvements?

Using home equity for home improvements can be a sensible financial strategy. Home equity loans or home equity lines of credit (HELOCs) can provide you with access to funds at generally lower interest rates compared to other types of home improvement loans, like personal loans.

What is after renovation value?

Within real estate and renovation loans, after renovation value (also known as after repair value) is the value of a home after you’ve completed renovations. It takes into account the total cost of your updates and the current value of the home. This is one of the most important terms to understand when it comes to qualifying for renovation loans.