Using A Home Equity Loan For Remodels, Renovations And Other Home Improvements
Need to renovate your aging kitchen? Maybe you need a third bedroom for your growing family. Renovations and home remodels such as these can be expensive. But you can fund these updates with a home equity loan, usually at an interest rate far lower than what you’d pay with a personal loan or by funding the renovations with your credit card.
How Does A Home Equity Loan Work For Home Improvements?
Your home’s equity is the difference between what you owe on your mortgage and how much your home is worth. If your home is worth $300,000 and you owe $200,000 on your mortgage, you have $100,000 of equity.
If you have enough equity, you can borrow against it in the form of a home equity loan. Say you have $100,000 in equity. You might take out a home equity loan of $80,000. You’d then receive that money in a single payment. But as with any home loan, you need to pay back your home equity loan in monthly payments, with interest. If you don’t pay your home equity loan back, your lender can foreclose on your home.
You can use the money from this loan for whatever you want. You can pay down high-interest-rate credit card debt or use the funds to cover a child’s college tuition. You can also use it to fund home repairs, remodels or renovations.
Pros Of Using A Home Equity Loan For Your Remodel
There are several benefits to relying on a home equity loan to pay for your home’s remodel. Here are some of the top advantages:
Low Interest Rates
You’ll generally pay lower mortgage rates when you take out a home equity loan. That’s because lenders consider home equity loans to be less risky than unsecured personal loans or credit card debt.
Home equity loans are secured by your home. If you don’t make your payments, your lender can foreclose on your home, giving your lender more protection and the freedom to attach a lower interest rate to your loan.
To qualify for the lowest rates, though, you’ll need a strong FICO® credit score. Lenders typically consider any FICO® Score of 740 or higher to be a very good one, and one that comes with the lowest interest rates.
The interest you pay on a home equity loan can be tax deductible, bringing you savings come income tax time. To qualify for the mortgage interest deduction, you must use your home equity loan to buy, build or substantially improve your home. Using your home equity loan funds to pay for a home remodeling or renovation will qualify. If you use your home equity loan, though, to pay off high-interest-rate credit card debt or pay for a child’s college tuition, you can’t deduct the interest you pay on the loan.
You can only deduct the interest you pay on up to $750,000 of combined mortgage debt. If you are paying off a $300,000 primary mortgage and an $80,000 home equity loan, then, you’ll be able to deduct all the interest you pay on these loans during the year. You must itemize on your taxes to claim the mortgage interest deduction. You can’t claim this if you instead take the standard deduction available to all taxpayers.
Upfront Lump Sum
When you take out a home equity loan, you’ll receive your funds in a single lump-sum payment. This gives you the freedom to use those funds immediately and on whatever home renovation or remodeling project you choose.
Return On Investment
Depending on how you spend your home equity loan dollars, you can increase the value of your home, which will pay off when it’s time to sell. Kitchen remodels, for example, generally help boost the value of your home. Adding an extra bedroom or building a primary bathroom can increase the value of your residence, too.
Long Payback Period
You also have flexibility in choosing a loan term. You might choose a shorter-term home equity loan, such as 5 years, if you want to repay your loan quickly and spend the least amount of interest. But you can stretch out your loan term – to, say, 10 or 15 years – if you want a smaller monthly payment. Just know that the longer your loan’s term, the more you’ll pay in interest during the life of that loan.
Cons Of Using A Home Equity Loan For Your Remodel
As with all loans, there are also some drawbacks of using a home equity loan:
Loan Is Secured By Your House
When you take out a home equity loan, your home is the collateral. If you don’t pay your loan back on time, then, your lender can foreclose and possibly take your home. This makes a home equity loan riskier for you than a personal loan or credit card debt, neither of which require any collateral.
You Have To Repay The Entire Lump Sum
You are required to pay back the entire amount you borrow when taking out a home equity loan. This holds true even if your home remodel doesn’t cost as much as you expected. Say you take out a home equity loan for $40,000 to cover a kitchen remodel. If that remodel costs $30,000, you still must pay back the entire $40,000 that you borrowed.
Additional Fees Increase Your Project Costs
You’ll pay closing costs and other fees charged by your lender and other third-party providers when you take out a home equity loan. These fees will vary, but you can expect to pay from 2% to 5% of the total amount you borrow. If you borrow $50,000, you can expect to pay from $1,000 to $2,500 in closing costs and fees, an expense you’ll have to include when determining how much your home remodeling or renovation project will cost.
Another Monthly Payment Can Strain Your Budget
When you take out a home equity loan, you are adding another monthly payment to your budget. Make sure you have enough income each month to afford this new payment by making a household budget that tracks your monthly expenses and income. This is the best way to determine whether you can afford a monthly home equity loan payment.
Other Options For Using Equity For Home Improvements
You do have two other main options that let you tap into your home’s equity to fund improvements or renovations. As with all borrowing options, they come with their own pros and cons.
Home Equity Loan Vs. Home Equity Line Of Credit (HELOC)
A home equity line of credit (HELOC) is similar to a home equity loan in that the amount you can borrow is based on the equity in your home. But unlike with a home equity loan, you don’t receive your payment in one lump sum. Instead, you receive a line of credit.
Say you have $100,000 in equity. You might take out a HELOC for $80,000. This money acts a bit like a credit card. If you need to pay for a primary bathroom remodel, you might borrow $15,000 of your HELOC to pay for it. Once you do, you have to pay back that $15,000, with interest. With a HELOC, you only pay back what you borrow.
Although both home equity loans and HELOCs give you the ability to fund home renovation projects, most agree that a home equity loan is better when you have a specific project in mind – and a specific dollar amount you want to borrow – while a HELOC is better if you want the flexibility to fund several projects.
Home Equity Loan Vs. Cash-Out Refinance
In a cash-out refinance you refinance for more than what you owe on your mortgage. You then receive the extra dollars in a lump-sum payment that you can spend on anything you’d like. Maybe you owe $200,000 on your existing mortgage. You might refinance for $270,000. You’d get the extra $70,000 in a lump-sum payment that you can use to pay for anything, including a major home renovation.
You’ll pay back your new loan in monthly installments, with interest. But instead of paying back $200,000, you’d pay back $270,000.
Unlike with a home equity loan, you’ll be left with just one mortgage loan after you close a cash-out refinance. This loan will have a new interest rate tied to it, which could be better or worse than your old rate.
How To Get A Home Equity Loan For Your Remodel
Applying for a home equity loan is much like applying for any other mortgage loan. Your lender will check your credit reports and your three-digit credit score. You’ll also provide your lender copies of your most important financial documents, such as your two most recent paycheck stubs, last 2 months of bank account statements, tax returns from the last 2 years and W-2 forms from the last 2 years.
Your lender will review this information to make sure you can afford your monthly payment. Once your lender’s underwriting team approves your loan, you’ll receive your lump-sum payment and a repayment schedule. You’ll pay back your loan with monthly payments, with interest.
The Bottom Line
If you’re ready for a home improvement or renovation project, consider applying for a home equity loan. You’ll spend less in interest than if you use your credit card or personal loans to finance such a project. And receiving your funds in a lump sum payment means you can get started on your renovation project quickly. You can start a mortgage application with us to see how much of a home equity loan – or cash-out refinance – you can qualify for.