The amount of equity you have in your home is defined as the total amount owed on your home subtracted from your home’s value. If your house is worth significantly more than you owe on it, you may be able to use that equity to make home improvements.
Before tapping into your home equity, make sure to consider the pros and cons that come with taking out a loan for home improvement. Read on to learn more about your options and how you can make the most out of your home equity loan or home equity line of credit (HELOC).
Benefits of using your home equity for home improvement
Home equity can be a smart way to finance a remodel, especially as interest rates remain low. The average home equity loan rate is currently about 5.1 percent APR, and the average HELOC rate is about 4.52 percent APR.
Benefits of using the equity in your home for home improvement include:
- Tax deduction: The interest you pay on home equity loans and HELOCs is tax deductible if the money is used to remodel, repair or otherwise improve the value of the home that secures the loan.
- Low interest rates: Both home equity loans and HELOCs carry low interest rates because they are designed to allow homeowners to use the equity in their homes to maintain and improve property values — and because the home is used as collateral for the loan.
- Return on investment: Investing in your home is a smart idea, whether you’re looking to sell or just create a more comfortable space for yourself and your family. If you’re tossing around the idea of selling your house, renovations may help your home sell more quickly and for more money.
Should I use a home equity loan or HELOC for my renovation?
Two of the most popular options for borrowing money for home renovations are home equity loans and home equity lines of credit. The two share many similarities; they both use the equity in your home, they both use your home as collateral and they both typically let you borrow up to 80 or 85 percent of your home’s value, minus your outstanding mortgage balance.
However, the two have several differences, and they each have their own individual pros and cons.
Home equity loans for home improvement
Home equity loans are structured more like a traditional mortgage, with a repayment period and a set schedule of payments that include both principal and interest. They are essentially second mortgages and typically come in terms of 10, 15, 20 or 30 years.
- Payments are structured and begin right away, which makes it easier to budget.
- Home equity loans usually have a fixed rate, so the amount you pay will likely stay at or close to the same amount each month.
- If you aren’t planning to start remodeling immediately, you can move the money to an interest-bearing account and earn money on your money.
- All money is disbursed upfront, making the loan a good option for large-scale improvement projects.
- If your remodeling project is going to be a lengthy process, you may be tempted to spend the money on other things instead.
- A home equity loan is a secured loan against your house, so if you stop making payments, the bank can take possession of your home.
- If home values take a dive, you may owe more on your loan than the home is worth.
- Since home equity loans serve as a second mortgage, they come with closing costs and fees.
Home equity line of credit, or HELOC, for home improvement
All HELOCs have a draw period and a repayment period. The draw period is the amount of time you have to use the line of credit you were approved for. Once that period expires, you can no longer withdraw funds, and you must start repaying the full loan.
- You can use as much or as little money as you need and only pay back what you use.
- Interest rates are usually lower than those of personal loans or credit cards.
- During the draw period, you may be given the option to make interest-only payments.
- HELOCs are variable-rate loans, which means the interest you pay will fluctuate and affect your monthly payments.
- It can be easy to take on more debt than you can afford, since you can borrow multiple times from your HELOC and don’t have to make payments right away.
- Many lenders charge an annual fee to keep the HELOC open, whether you use it or not.
- If home values fall, you may owe more than the home is worth.
- It can take a bit longer to get approved for a HELOC than a home equity loan.
Getting the most from your home equity loan or HELOC
Whether you choose a home equity loan or a HELOC for your renovation, keep in mind some best practices for using your loan funds.
Maximizing your home equity loan
Since home equity loans are disbursed in a lump sum, they can be useful for bigger projects. If you are planning a relatively large home improvement project, like a complete kitchen remodel or the addition of another section onto your home, a home equity loan may be a better solution for you than a HELOC. However, it is imperative that you have a financial plan in place and are able to pay off the loan.
- Make your payments on time: It is important to consistently make your monthly payments. Since you use your home as collateral, you run the risk of losing your home if you don’t make your payments on time.
- Stick to your budget: Before you apply for a home equity loan, it’s wise to create a budget or a financial plan for how you will use the money. Since it’s distributed in a lump sum, it could be easy to quickly spend the cash on things other than home improvement.
- Use it for larger projects: Due to the distribution of the funds, this loan may be best used for larger-scale home improvement projects. Remodeling kitchens and bathrooms or making major additions to your home are a few examples of how you can best maximize your home equity loan.
Maximizing your HELOC
HELOCs can be a great option for smaller home improvement projects, since they’re disbursed over a longer period of time. Unlike a home equity loan, a HELOC is a revolving line of credit, like a credit card. This means that you can take out how much you want, when you want. While this is convenient, you still have to pay off the loan by the end of the repayment period or risk losing your home.
If you’re planning smaller-scale renovations or renovations that will continue for a number of years, this may be a good option for you. Plus, interest may be tax deductible if you use your loan for home improvement projects only.
- Make your payments on time: As with a home equity loan, it is crucial to make your payments on time. While you’re only required to make payments on interest during your HELOC’s draw period, it may make sense to make payments on the principal as well; that way, you’ll lower your monthly payments during the repayment period.
- Be aware of the fees: HELOCs can come with fees that may cut into the value of the loan. Annual maintenance fees and closing costs are two common fees with a HELOC.
- Use it for smaller projects: HELOCs are most effective when used for smaller-scale, long-term projects, since you have some flexibility over how much money you actually borrow during the draw period.
High-impact home improvements
People who use HELOCs to pay for home renovations might want to consider the return on their investment. For example, if you sink too much into a master bathroom, you might not be able to recoup the cost.
Using stats from Remodeling Magazine, here are a few of the most popular ways to leverage your home equity for home improvements:
- Garage door replacement: 94.5 percent cost recouped.
- Bath remodel (midrange): 64 percent cost recouped.
- Roof replacement (asphalt shingles): 65.9 percent cost recouped.
- New deck: 72.1 percent cost recouped.
- New master suite (midrange): 58.5 percent cost recouped.
- Major kitchen remodel (midrange): 58.6 percent cost recouped.
Alternative home improvement loans
If you’d rather not use your home equity for home improvements, you have other options.
One option for securing money for a remodel is a personal loan. Because personal loans are unsecured debt, interest rates have a broad range, from about 3 percent to 30 percent or more, depending on your credit history, income and other factors.
However, personal loans can be a useful short-term solution to remodeling when you don’t have much equity but the improvements you are planning will increase the value of your home significantly. Though rates for personal loans are higher than those of home equity loans, you don’t risk losing your home if you default.
If you have discipline and excellent credit, you may qualify for a credit card offering a 0 percent interest rate for a certain term. If you qualify for a credit card with a 0 percent interest promotion, it can mean financing a home improvement with no interest, provided you can pay the credit card off before the promotional term ends.
Be careful, though, because interest rates can and will go up if you are late or miss a payment, and they can reach astronomical levels. So be sure to make payments on time and know what interest rate you’ll be paying if you can’t keep up.
Another option for using your equity for a home improvement project is through a cash-out refinance. With a cash-out refinance, you refinance your mortgage for more than what you currently owe on your mortgage, pay off your current mortgage and take the difference in cash.
Keep in mind that cash-out amounts may be limited, and that this option is only smart if you can get a lower interest rate on your mortgage. Before committing, get quotes from a few different lenders offering refinancing.
The bottom line
If you’re looking to renovate your home, tapping your home equity may be a good way to find funding. Shop around at multiple lenders to find the best deal on a home equity loan. Home improvement projects are already expensive enough, and even a small difference in the interest rate can save you thousands of dollars over the years.