Home renovations and repairs can be expensive. For major projects, many homeowners turn to home equity loans to finance the costs rather than paying out of pocket. With home values rising in recent years, tapping into your home equity can provide funds for remodeling while allowing you to keep your current mortgage rate.
What is a Home Equity Loan?
A home equity loan is a type of second mortgage that allows you to borrow against the equity in your home. Equity is the difference between your home’s market value and the amount you still owe on your mortgage.
For example, if your home is worth $300,000 and you have $100,000 remaining on your mortgage, you have $200,000 in equity. With a home equity loan, you can typically borrow up to 85% of your available equity.
Home equity loans provide a lump sum of cash upfront at a fixed interest rate. You immediately begin making principal and interest payments with terms generally ranging from 5 to 30 years. The funds can be used for any purpose, including home renovations.
Pros of Using a Home Equity Loan for Remodeling
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Lower Interest Rates Home equity loans typically have lower interest rates than other financing options like personal loans or credit cards Rates are closer to current mortgage rates
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Predictable Payments: With fixed rates, your monthly payment stays the same over the loan term, allowing for easier budgeting.
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Tax Benefits: You may be able to deduct the interest on up to $100,000 of home equity debt on your tax return if funds are used to substantially improve your home.
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Improve Home Value: Certain renovations like kitchen and bathroom updates can increase your home’s worth. This added value can boost your equity over time.
Cons of Using a Home Equity Loan for Remodeling
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Closing Costs: You’ll pay 2-5% of the loan amount in fees like origination charges, application fees, and appraisal fees.
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Home at Risk: If you default, the lender can foreclose. You risk losing your home.
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Prepayment Penalties: Some lenders charge fees for paying off the loan early. Review the terms first.
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Temptation to Overspend: Having a large lump sum on hand could lead to spending on things besides the intended home renovation.
Tips for Using a Home Equity Loan for Remodeling
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Shop around and compare rates and fees from multiple lenders. Look for the lowest interest rate and costs.
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Consider a HELOC if your project will take place over an extended timeframe. The revolving credit line allows you to access funds as needed.
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Have a detailed renovation budget and timeline planned out before taking out the loan. Know exactly how you’ll use the funds.
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Only borrow what you need for renovations. Taking on too much debt can be risky.
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Prioritize renovations that will increase your home’s value, like updated kitchens and baths. Avoid over-improving for your neighborhood.
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If possible, pay for labor and materials directly from the loan rather than taking out a lump sum in cash. This can help avoid spending money elsewhere.
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Make payments on time. Setting up autopay can help avoid missed payments and fees.
Alternatives to Home Equity Loans
If a home equity loan isn’t right for your situation, other options include:
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Cash-out refinance: Refinance your mortgage for more than you owe and take the difference in cash.
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401(k) or IRA loans: Borrow against your retirement savings without tax penalties.
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Personal loans: An unsecured loan with higher rates but no home collateral required.
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Credit cards: Can work for small projects if you pay off the balance during a 0% intro APR period.
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Savings: Paying cash avoids finance charges but may take longer to save up funds.
The Bottom Line
Tapping home equity through a home equity loan can provide an affordable way to finance home remodeling projects. But make sure to carefully evaluate the costs and risks before moving forward. Setting a realistic budget and repayment plan is key to successfully using home equity for renovations.
What Is a Home Equity Loan?
A Home Equity Loan is a type of lump sum loan that allows homeowners to borrow money using their home as collateral. Home equity loans are considered “second mortgages,” as they are second in position compared to your first mortgage. A Home Equity Loan works by allowing you to borrow a lump sum against your home’s value. Technically, you can use the lump sum of money that you get from a Home Equity Loan for anything, but it is typically used for home improvement projects, paying for college, medical expenses, debt consolidation, and business or wedding expenses.
The biggest advantage of using a Home Equity Loan is the fixed low-interest rates. Since interest stays the same throughout the loan term, the monthly payment will be the same each month, and easily manageable for a tight budget. The biggest disadvantage of using a Home Equity Loan is the potential run out of funds if the lump sum is mismanaged or you run into an unexpected need for more funds (which is very common during home improvement projects).
Tips for Choosing the Best Option for You
HELOCs and home equity loans are both considered “second mortgages,” as they are in second position compared to your first mortgage, and you’re borrowing from your home as collateral.
However, HELOCs function as a “line of credit,” like credit cards, where during the draw period, you can draw smaller amounts of money only when you need it. With home equity loans, you’re required to borrow the entire loan amount in a lump sum and begin paying it off almost immediately.
People sometimes prefer HELOCs because they are more flexible if you’re not sure how much money you’ll end up needing, but want the freedom to tap into your line of credit at any time.
Home equity loans are normally fixed-rate, and HELOCs are generally variable-rate, which is another difference between the two options.
Ask yourself about the purpose of the loan.
A home equity loan is good if you know exactly how much you need to borrow and how the money will be used. Once approved, you’re guaranteed that amount, and you receive it in full.
A HELOC is good if you’re not sure how you’ll need to borrow it or when exactly you’ll need it. It gives you access to cash for a set period of time.
If you aren’t comfortable with the HELOC’s variable interest rate, you may prefer a home equity loan for the stability and predictability of fixed payments.
Make sure you do not borrow more than you can afford to pay back.
Try the RenoFi Loan Calculator to see how much you can borrow.
Or, if you’d like to explore your options, contact a RenoFi Advisor to learn more.
Should I Use a HELOC for Home Repairs?
FAQ
Can you use a home equity loan for renovations?
What is the 30 percent rule for home renovation?
What is the monthly payment on a $50,000 HELOC?
What are the best home renovation loans?
And a Home Equity Loan is the best way to do it! Home equity loans are one of the best home renovation loans because they not only have lower interest rates than most other traditional renovation loan options, but they also offer large loan amounts that help homeowners tackle more of their project wishlist in one shot.
What is a home equity loan?
A home equity loan lets you borrow a lump sum at a fixed rate with a payback period of up to 30 years. The biggest risk with a home equity loan —or any other form of home equity borrowing—is that your loan servicer could foreclose on your property because your home serves as collateral for the loan.
Can you use a home equity loan for a remodel?
You can use a home equity loan for remodels or renovation projects by tapping into the equity you’ve built into your home and using it as collateral for a loan. As you read on, consider whether a home equity loan is the right choice to finance your project.
Should you use a HELOC to finance a renovation?
Often homeowners use HELOCs to finance major renovation projects, as the interest rates are lower than they are on personal loans and credit cards. That’s because you can continually build equity as you live in your home and then access your home equity when you need it with a home equity loan or HELOC.