A home equity loan is a common option for those considering a big remodel or some slight home improvements. Read on to learn how you can use it.
Are you looking to upgrade your home by remodeling your kitchen, finishing the basement, or taking on some other type of home improvement project?
If so, you fall into the 61% of homeowners who’ve been doing the same.
While finding the money for your dreams of home improvement can seem complicated, you could be eligible to apply for a home equity loan to finance those projects.
So, how does a home equity loan work for home improvements? And should you take one out instead of a personal loan or other financing option?
This blog is designed to alleviate the headache of financing your remodeling projects so that you can focus on the fun stuff, like picking out paint colors and stuffing your Pinterest boards with DIY projects. Let’s dive into detail about a home equity loan for remodel projects and how this unique type of home improvement loan works.
Can I Take Equity Out of My House for Home Improvements?
As you take a closer look at each loan option for financing home renovations, you may decide to take equity out of the home to help cover the costs.
When comparing a home improvement loan vs. home equity loan, a home equity loan is a loan taken out against the equity you have in your house. Whether or not you’re eligible for such a loan depends on the amount of equity you’ve developed.
- Home equity is the difference between the current market value of your home and any mortgages or loans still owed on it. For example, if your house is valued at $300k and you owe $150k in loans, your total equity is $150k.
- If you’ve been making regular payments to your mortgage, chances are you’ve already been building up home equity that you can access for home improvement projects.
- A home equity loan functions as a second lien against the home (in addition to your mortgage), so it’s important to consider the pros and cons of taking one out.
How Does a Home Equity Loan Work for Home Improvements?
Home equity loans are disbursed to borrowers in the form of a lump sum. You can use a home equity loan calculator to get an idea of how much you can expect to receive, but in most cases, you’ll be able to borrow up to 80% of your home’s value. The money can be used however you wish. You’ll pay it back in the form of monthly installments, usually with fixed rates.
If you’ve already developed equity, you can apply for a loan. Keep in mind that, as with most loans, you’ll need to be approved based on other factors like credit score and income as well. However, bad credit doesn’t mean you can’t renovate your house. Read on to discover alternative ways to tackle home improvement loans with bad credit.
What Is a Renovation Home Equity Loan?
What is a renovation loan? A renovation home equity loan is a type of loan that can be used for—you guessed it—home renovations. A fixed-term loan, also known as a second mortgage, is granted to a homeowner from a lender company.
This type of loan may be used to cover an array of renovations such as bathroom remodels, solar panel installations, garage door replacements—you name it. However, home equity loans can be used in several other ways as well.
Other uses for home equity loans may include:
- Covering medical bills
- Paying off student loans
- Making large purchases like a car or boat
- Starting a business
- Paying down credit card debt
- Funding a wedding
- Covering emergency expenses
- Making investments
Home equity loans typically carry a lower interest rate than personal loans. The biggest risk, however, is a person taking on additional debt that’s secured against their house.
Building Home Equity
If you haven’t developed substantial equity yet, consider the following:
- If you’re purchasing a new home, you can build home equity by paying more upfront with a higher down payment. For example, making a 20% down payment on a house with a $250k price tag translates to $50k in home equity right off the bat.
- Making regular payments on your mortgage—or paying extra, if you can spare the funds—will increase your equity over time.
- Home improvements can increase the value of your home. (By reading this article, you’re already on the right track!)
Should I Take Out a Home Equity Loan to Remodel?
The right strategy for funding a home improvement project will depend on the needs and qualifications of the borrower.
To determine if a home equity loan is right for you, take the following steps.
- Calculate the closing costs of your project and draw up a detailed budget for your expenses.
- Determine how much equity you’ve built in your home. The total amount needed for approval will depend on the lender but, in most cases, you’ll need to have between 15-20%.
- Before taking out a home equity loan, be sure to gather as much information as possible about alternative funding options for the projects you have in mind. Cross-examine the benefits of each and proceed with whatever makes the most financial sense for you.
Home Improvement vs Home Equity Loans
Home equity loans are just one way of lightening the financial load of remodeling your home. Another option is a home improvement loan. Though the two are similar in name, there are some important distinctions to be made between home equity loans and home improvement loans.
Home equity loans:
- Have fixed interest rates and payback periods
- Are secured by your home
- May be eligible for tax benefits
- Do not require pre-qualification
In contrast, home improvement loans:
- Have a fixed monthly payment
- Are unsecured
- Are not eligible for tax benefits
- Require pre-qualification
- Tend to have higher interest rate fees than home equity loans
Each type of loan comes with its own sets of risks and rewards, but the main appeal of a home improvement loan is that it can be suitable for homeowners who have not yet built up enough equity in their homes. Additionally, home improvement loans are often unsecured, meaning your home and property will not be used by the lender or bank as collateral as it would be with a home equity line.
Many homeowners are hesitant to take out home equity loans that function as second liens on their homes. After all, a higher outstanding debt balance from the loan amount means higher monthly payments towards your housing and more long-term financial risk (should you be unable to keep up with your bills during the repayment period).
If you’re hesitant to take out a home equity loan for home improvements, consider these other solutions:
- HELOC loan – Similar to a home equity loan, a HELOC loan for home improvement is taken out against the value of your house. In contrast, it functions as a line of credit, which means you’ll only be responsible for paying back the loan amount that you actually spend.
- Sale-leaseback – Want to free up cash for improvements without taking on more debt? A sale-leaseback solution makes it possible to convert your equity to cash, make upgrades, and even collect appreciation when you’re ready to move.
How to Use a Home Equity Loan for Home Improvements
Once your application is approved for a home equity loan, the money is disbursed in full and will be available for you to use however you please. When deciding how best to use a home equity loan for a home renovation project, you’ll want to consider projects that offer the highest return on investment.
How much will your project cost? And how much could it potentially increase the value and state of your home?
According to HGTV, these home remodels are likely to have the highest pay-off:
- Minor Bathroom Remodel – Replace or re-caulk the bathroom tub, update the tile flooring, or revamp the vanity. The average return rate for these kinds of minor renovations is 102%.
- Landscaping – Consult with a landscape architect to devise a plan for updating the trees, shrubs, and garden space available at your home. Making improvements to your home’s landscaping has an average return rate of 100%.
- Minor Kitchen Remodel – Give your kitchen a makeover by replacing cabinets, updating the flooring, or swapping old appliances for new ones. Investing in a kitchen remodeling project has an average return rate of 98.5%.
- Exterior Improvements – These kinds of improvements may include adding or replacing vinyl siding, giving your house an update, trendy paint color, or improving entryways. This project brings in an average return of 95.5%.
- Attic Bedroom Conversion – Is your attic just sitting around collecting dust? Why not let the space serve more of a purpose by turning it into an extra bedroom for your home? The average return rate for this project could be around 93.5%.
- Major Kitchen Remodel – From countertops and cabinets to flooring and appliances, this kind of remodel is a big undertaking, but one that could be well worth the time and money invested. The average return rate for major kitchen renovations is 91%.
Assess the spaces of your home, make a list of your must-do renovations, and consider the home remodel financing options according to the funds required.
Upgrade Your Home on Your Terms With a Sale-Leaseback Program
If you’ve got a number of home remodels on the horizon, you need to find a financing option that protects your long-term financial health. However, if taking out a loan is something you’d prefer to avoid, consider converting your home equity into cash with a sale-leaseback.
A sale-leaseback program could be the answer to your home improvement financing needs. This means you sell your house, getting the cash from the sale as well as a lease to stay in the house as a renter. By selling your home and converting equity into cash, you can fund your projects and stay in your home for as long as you need. Once you’re ready, you can decide to repurchase your house or move out or sell it on the open market.
If you’re looking to complete some remodel projects, it can be a good idea to take out a home equity loan in order to fund your vision. However, there are other options available to you. Talk to a financial advisor to learn all about each one and to decide what will work best for your situation.
- Bankrate. Requirements for a home equity loan or HELOC in 2021. https://www.bankrate.com/home-equity/requirements-to-borrow-from-home-equity/
- Investopedia. A Guide for Home Equity Loans and HELOCs. https://www.investopedia.com/mortgage/heloc/
- NerdWallet. 2020 Home Improvement Report. https://www.nerdwallet.com/blog/2020-home-improvement/