Smart ways to use your home equity for remodeling

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The amount of equity you have in your home is the portion of your home that you’ve already paid off. If your house is worth significantly more than what is still owed on your mortgage, you may be able to use that equity to pay for home improvements or renovations.

But before tapping into your home equity, 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 of your home equity loan or home equity line of credit (HELOC).

Why you should consider a home equity loan for remodeling

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 6.37 percent APR, and the average HELOC rate is about 4.41 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 create a more comfortable space for you 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.

Key drawbacks of using a home equity loan for home improvement

While there are many benefits to taking out a home equity loan for home improvements, it’s important to remember that there are also a few drawbacks.

1. Your home is collateral for the loan

“The biggest con to consider is the risk involved,” says Laura Sterling, vice president of marketing of Georgia’s Own Credit Union. “Since your home acts as collateral to secure the loan, your home is at risk when you take out a home equity loan. If you cannot pay back your loan, you become vulnerable to foreclosure.”

2. The value of your property could decline and the bank may recall the loan

From time to time there are market corrections or downturns, which can cause the value of your home to decline significantly. This could create a challenging situation, particularly if you have a lot of debt associated with the home, says Mark Charnet, founder and CEO of American Prosperity Group.

“If the value of the home falls to where the loan balance exceeds the home’s value, the bank may call in the loan and force you to pay it all off or a significant amount of it,” Charnet says. “Failure to do so can possibly lead to a foreclosure action by the lender. Never loan yourself so much that a 5 to 7 percent reduction in your home’s value will trigger this type of ‘underwater’ event.”

3. A home equity loan might be more than you need 

Using home equity for home renovations works best when you’re making significant improvements or have multiple uses for the loan funds.

“A home equity loan can be a great option for borrowers if they’re looking to cover a large expense,” says Nicole Straub, general manager of Discover’s home loans unit. “Loan amounts tend to be higher than for unsecured loan products like personal loans.”

If you have a smaller project in mind, a home equity loan may still make sense, particularly if you plan to use some of the proceeds for consolidating debt or paying off high-interest credit cards.

4. The loan comes with additional costs

Since home equity loans serve as a second mortgage, you’ll pay closing costs and fees, which can range from 2 percent to 5 percent of the loan, Sterling says.

“If you’re planning a $30,000 kitchen remodel, you will end up paying much more than $30,000 in interest, closing costs and other fees,” she says. “If you have a home equity line of credit, you also run the risk of interest rates rising.”

Home equity loans vs. HELOCs for home 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 percent or 85 percent of your home’s value, minus your outstanding mortgage balance.

However, the two have several differences, and they each have their 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.

Pros

  • 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 up front, making the loan a good option for large-scale improvement projects.

Cons

  • 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.

Pros

  • 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.

Cons

  • 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.

5 ways to use a home equity loan for home improvement

1. Kitchen remodeling

Kitchen remodels are the sixth-most popular project in the country, according to HomeAdvisor’s 2021 True Cost Report, with 23 percent of households undertaking some form of kitchen remodel, says Mischa Fisher, chief economist for HomeAdvisor.

In addition, according to Remodeling’s latest Cost vs. Value report, minor kitchen remodels recoup 77.6 percent of their cost in home value.

“Because of the relatively higher cost of kitchen remodels, financing these projects with lower-interest home equity loans could be a great way to improve your home value,” Fisher says.

2. Bathroom remodeling

Bathroom remodels also provide relatively good return on investment, with 64 percent of a midrange remodel’s cost recouped, according to Remodeling’s 2020 Cost vs.Value report.

“Bathroom remodels were the most-planned project for 2021 in the HomeAdvisor True Cost Report, but they also carry a high average cost of $13,401,” Fisher says. “Since that is more cash than most people would like to pay up front, bathroom remodels could be one of the best options for financing.”

3. Building a deck

Wood deck additions have seen one of the most significant increases in popularity of the major projects tracked by HomeAdvisor’s True Cost Report, rising from the 10th most completed project of 2020 to the seventh most planned project of 2021, Fisher says.

“They also provide a solid return on investment, according to Remodeling’s 2020 Cost vs. Value report, with 72 percent of their cost recouped in home value,” he says.

4. Upgrading your garage door

Replacing your garage door practically pays for itself, says Sterling, of Georgia’s Own Credit Union.

“While it’s not necessarily the splashiest home improvement one can make, homeowners recoup 94.5 percent of their investment,” she says. “In many cases, this home improvement may be a necessity if the garage door is not working properly.”

5. Roof replacement

Roof replacements are also a wise investment, Sterling says. This type of project can provide a return of 65.9 percent, according to Remodeling’s 2020 Cost vs. Value report.

“Like garage doors, this may also be a necessity if you have an old or damaged roof. You also get a better return on shingles as opposed to metal roofs,” she says.

Alternatives to home equity loans for home improvement

If you’d rather not use your home equity for home improvements, you have other options.

Personal loans

Because personal loans are unsecured debt, interest rates range from about 3 percent to 36 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.

Credit cards

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.

Cash-out refinance

With a cash-out refinance, you refinance your mortgage for more than what you currently owe, replace your current mortgage with a new one 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 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. But be sure to shop around at multiple lenders to find the best deal on a home equity loan. Home improvement projects can be expensive enough, and even a small difference in the interest rate can save you thousands of dollars over the years.

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Written by
Natalie Campisi
Mortgage reporter
Natalie Campisi is a former mortgage reporter at Bankrate.
Edited by
Student loans editor