Smart ways to use your home equity for remodeling

Your home equity represents the share of your home that you own outright — either paid for in cash or repaid on your mortgage. If the value of your ownership stake is substantial,  you could utilize that equity to fund repairs or upgrades to your home: Use your home’s worth to further enhance its worth. Nevertheless, it’s important to carefully evaluate the advantages and disadvantages before accessing your home equity for remodeling purposes.

Key takeaways

• If you want to tap into your home equity for a home improvement project, it’s important to understand how home equity financing works.

• Two popular options for tapping into home equity include a home equity loan or a home equity line of credit (HELOC), each of which has its pros and cons.

• Before using a home equity loan or HELOC for remodeling, consider if the project will add value to your home, and develop a budget/schedule for paying the funds back.

How does a home equity loan for home improvement work?

Home equity financing is available in two primary options: home equity loans and HELOCs. In both cases, your home serves as collateral, which means failing to make monthly payments puts it at risk of foreclosure.

Home equity loans function similarly to mortgages: You borrow a lump sum at a fixed interest rate. Repayments start immediately and cover both interest and principal over a term ranging from five to 30 years.

HELOCs provide a line of credit, typically with a variable interest rate, though some lenders offer fixed-rate alternatives. HELOCs generally have a draw period spanning around 10 years, during which you can access funds and make interest payments (with the option to repay the principal). After the draw period, a repayment period of 10 to 20 years begins, during which you can no longer access the funds and are obligated to make both interest and principal payments.

Both types of financing can be utilized for various expenses, such as medical bills, college tuition or debt consolidation, but home improvements are one of the most popular — because if the money’s utilized for home-related repairs or upgrades, the loan’s interest may be tax-deductible (see “Benefits” below).

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The amount you can borrow is typically determined by the size of your ownership stake and the loan-to-value ratio (LTV), which compares the loan size to the property’s value. Generally, lenders limit your borrowing capacity to around 80 percent or 85 percent of your equity. However, specific limits can depend on factors like your credit score, annual income and payment history.

Benefits of using home equity for home improvement

Lower interest rates

Home equity loans and lines of credit (HELOCs) offer comparatively lower interest rates because they are secured loans: that is, they are backed by your home as collateral. They parallel mortgage rates, running slightly higher — but still far lower than credit cards or personal loans. Of course, individuals with good credit scores have access to the most competitive rates.

Tax deduction

You can deduct the interest you pay on home equity loans and HELOCs annually on your tax return. But certain conditions apply. To qualify for the deduction, the funds obtained must have been used to purchase, repair or make significant improvements to the home securing the loan.

As of 2023, joint filers can deduct interest on up to $750,000 of eligible loans, while single filers or married couples filing separate returns can deduct interest on up to $375,000. (These limits apply collectively to all your mortgages and home-related loans, by the way.) You must itemize your deductions to take advantage of this benefit.

More money

“A home equity loan can be a great option for borrowers if they’re looking to cover a large expense,” says Nicole Straub, former senior vice president and general manager of Discover’s student loans unit. “Loan amounts tend to be higher than for unsecured loan products like personal loans.” You generally have a longer repayment horizon, too.

Possible return on investment

Using your home equity to invest in your home can be a smart financial move. Expanding the liveable space, adding amenities, modernizing systems and fixtures, improving appearance and curb appeal — all these things enhance a property’s worth. If you’re considering selling your house, renovations might help it sell more quickly and for more money. If you’re staying put, they’ll help it appreciate (or at least not depreciate) long-term. And of course, improve your quality of life in the meantime.

Drawbacks of using home equity for home improvement

Your home is on the line

Before committing to a home equity loan or HELOC, it is crucial to be aware of the major downside: the potential of losing your home if your financial circumstances take an unforeseen turn and you are unable to keep up with the loan payments. In such cases, the lender may initiate foreclosure proceedings, and you could end up losing your home.

The loan might be more than you need

Home equity financing tends toward the big time: five-figure sums at least. Often, lenders have minimum borrowing requirements, which means you may need to borrow a substantial sum of money, potentially more than what you realistically require. You could repay the excess early, of course, but there might be penalties to do so.

Additional costs

It’s important to note that obtaining a home equity loan involves additional expenses. Since it is essentially a second mortgage, you will incur closing costs and fees, typically ranging from 2 percent to 5 percent of the loan amount. These costs can include charges like an origination fee and appraisal fee. When evaluating whether the loan is financially viable for your specific situation and needs, it is essential to factor in these fees and include them in the overall cost of the loan.

How do you get a home equity loan for your remodel?

There is a wide range of lenders in the mortgage industry that provide home equity financing, although availability may vary by state, particularly for HELOCs. While most lenders offer home equity options, there are specialized firms that focus solely on home equity loans and HELOCs, without offering purchase mortgages.

• Banks: Major retail banks such as Bank of America, Fifth Third Bank and Citizens Bank provide home equity products. If you are an existing customer of these banks, you may get additional benefits..

• Credit unions: Credit unions can be local, national, or regional and often have membership criteria based on factors like location or profession. Examples include Alliant Credit Union and PenFed Credit Union, which may offer home equity financing to a wide range of eligible members.

• Mortgage lenders: If you originally obtained your mortgage from a lender such as CrossCountry Mortgage, Guaranteed Rate or Rocket, they may also provide home equity financing options to their existing customers.

• Online-only lenders: There are online-based specialists in home equity financing, including well-established operations like Discover and newer players like Figure. Spring EQ is another online lender that allows certain borrowers to access up to $500,000 in equity.

Home equity loans vs HELOCs for home renovation

Home equity loans and HELOCs have numerous similarities: They both leverage the equity in your home, they both require your home as collateral, and they typically enable you to borrow up to 80 percent or 85 percent of your home’s value, minus the remaining balance on your mortgage. However, despite these resemblances, there are significant distinctions between the two, and each comes with its own advantages and disadvantages.

Home equity loans for home improvement

Home equity loans resemble traditional mortgages, following a predetermined payment schedule that includes both principal and interest. Essentially, they act as second mortgages and are typically available in terms of 10, 15, 20 or 30 years.

Pros

• Structured payments: Home equity loans have scheduled payments that begin immediately, allowing for easier budgeting and financial planning.

• Fixed interest rate: These loans often come with a fixed interest rate, ensuring that your monthly payment remains relatively stable or only experiences minor fluctuations.

• Earning potential: If you don’t intend to begin remodeling right away, you have the option to transfer the loan funds into an interest-bearing account and earn additional income on the borrowed money.

• Lump sum disbursement: With a home equity loan, you receive the entire loan amount upfront, making it an ideal choice for improvement projects that require a significant upfront investment, or whose exact cost you know.

Cons

• Since you receive a lump sum, it can be tempting to divert the loan funds toward other expenses, especially if the renovation gets delayed or is dragging on.

• If home values drop suddenly, it could leave you in a situation where you owe more on the loan than the actual worth of your home, a state of negative equity.

• Home improvement projects’ total costs can be unpredictable, and your loan could fall short. Or it could be too much (meaning you incurred interest charges you didn’t need to have).

Home equity line of credit (HELOC) for home improvement

HELOCs are structured with a draw period and a repayment period. During the draw period, you have the flexibility to borrow money from the line of credit, and typically, you are only required to make interest-only payments. Once this period concludes, you can no longer access funds, and you must commence repayment of both the principal amount borrowed and the interest.

Pros

• Flexibility: With a HELOC, you have the freedom to use as much or as little money as you need, and to draw it whenever you need it. That’s ideal for long-term renovation projects, in which you typically pay contractors at set intervals.

• Limited interest: You are only obligated to repay the amount of the credit line you have actually utilized, and you only pay interest on the amount you’ve actually withdrawn.

• Good for the unpredictable: HELOCs can be ideal if you’re not certain how much your projects will ultimately cost or how long they’ll take. Since the balance is replenishable, you’re less likely to fall short in case of cost overruns, too.

Cons

• Variable interest rates: The interest rate will fluctuate, affecting your monthly payments and potentially leading to increased costs. If your project’s dragging on and  interest rates rapidly climb, as they did in 2022, repayments could get expensive.

• Big debt burden: Since you can borrow from your HELOC multiple times and typically don’t have to start repaying the principal immediately, it can be easy to accumulate a big balance, and encounter sticker shock when payments start including both interest and principal.

• Annual fees: Many lenders charge an annual fee to maintain an open HELOC account, regardless of whether you use the line of credit or not.

• Dinged credit: Even if you haven’t tapped the full amount of your HELOC, the entire line shows up as debt on your credit report. That could hurt your credit profile, making other financing difficult to get.

Alternatives to home equity loans for home improvement

If utilizing your home equity for home improvements is not your preferred route, there are alternative options available to consider:

• Personal loans: Personal loans are unsecured debt, and interest rates can range up to 36 percent, depending on various factors such as credit history and income. While rates are higher compared to home equity loans, personal loans can be a viable short-term solution for remodeling projects that have the potential to significantly increase your home’s value. The advantage is that you do not risk losing your home if you default on the loan.

• Credit cards: If you possess excellent credit and have discipline in managing your finances, you may qualify for a credit card with a 0 percent interest rate for a specific period. Taking advantage of such a promotional offer means you can finance your home improvement project without incurring any interest, provided you can pay off the credit card balance before the promotional period ends. However, it is crucial to be aware that interest rates can escalate significantly if you miss or delay payments.

• Cash-out refinance: With a cash-out refinance, you replace your existing mortgage with a new one that exceeds your current outstanding balance, allowing you to receive the difference in cash. It’s important to note that there may be limits on the amount you can cash out, and this option is only beneficial if you can secure a lower interest rate on your mortgage. Before committing to a cash-out refinance, it is advisable to obtain quotes from multiple lenders offering refinancing services.

What to consider before taking a home equity loan for remodeling

Before committing, it’s smart to carefully weigh the goals and consequences of pursuing a HELOC or home equity loan for home improvements. Here are two crucial questions to ask yourself.

Does the remodel add value to your home?

Ask yourself: Will tapping into your home equity to fund a remodel job increase your home’s worth? Renovations can vary greatly in their return on investment — anywhere from over 100  percent to 30 percent. Frankly, the majority don’t recoup their costs. And even if the returns are positive, don’t assume that because you put in an $80,000 swimming pool that you have bumped your’s home’s fair market value by $80,000, either.

Consult a real estate agent or an appraiser as to which sort of renovations really enhance home value and appeal to buyers, and what sort of projects offer the most bang for the buck. Generally, a more modest redo offers better return than a deluxe one.

Of course, home value isn’t purely measured in monetary terms. By remodeling your home, you have the freedom to tailor the changes according to your family’s specific tastes and needs. Whether it’s creating a spacious kitchen with a large island that accommodates your culinary adventures or incorporating a practical drop zone with ample storage for multiple children, you can customize the renovations to perfectly suit your lifestyle and desires.

Did I establish a budget/repayment plan before applying for a loan?

It’s also important to carefully budget how much you can afford to borrow in the form of a home equity loan or HELOC, and how long it will take to repay what you borrow. Forecasting these numbers can help you make a more informed decision and prevent borrower’s remorse that can occur if you can’t pay your bills. Remember to account for the unexpected in your budgeting and forecasting, such as the costs associated with an unforeseen illness or a layoff. And remember: Renovations almost always take longer and cost more than originally anticipated.

Bottom line on home equity for home improvements

If you’re considering home renovations and need funding, leveraging the equity you have in your home can be a viable option. But they should be major expenditures. If you have smaller-scale projects or renovations planned, it may not be practical to opt for a loan that entails high minimum borrowing amounts, involves closing costs and requires your home as collateral.

It’s important to explore multiple lenders to secure the most favorable terms for a home equity loan. Even a slight variation in the interest rate can result in significant savings over the long term. Taking the time to compare offers and find the best deal can potentially save you thousands of dollars in the years to come.

Additional reporting by Erik J. Martin