How to Use Home Equity for Remodeling

Ways to Use Home Equity for Remodeling

From replacing a roof or updating an HVAC system to adding a pool or updating a bathroom, the equity in your home can help you pay for large home repairs and remodels. But before tapping your home's equity to finance a big renovation, it's important to understand how each type of home equity financing works.

Home Equity Loan

A home equity loan, a type of second mortgage, provides a one-time lump sum that you then repay in fixed installments over a set term—usually five to 30 years. Lenders generally allow you to borrow up to 75% or 85% of your home's equity.

Home equity loans are secured by your home, so interest rates tend to be lower than with credit cards or personal loans. Rates are also fixed, so you don't have to worry about them fluctuating with market shifts. Home equity loans can be a smart choice when you need to cover one large expense.

HELOC

A HELOC is a revolving credit line you can borrow from repeatedly as you pay down the balance. So instead of getting a lump sum, you can borrow what you need up to a certain amount and only pay interest on the amount borrowed during the loan's draw period. Interest rates are variable and typically fluctuate over time.

You can usually borrow 60% to 85% of your home's equity. Borrowing timeframes are limited to a draw period—typically 10 years. When the draw period ends, you can no longer borrow and must repay the HELOC in full, including principal and interest (usually over 20 years). Thanks to their flexibility, HELOCs can be a good fit for ongoing expenses, such as a home remodel that takes several months or longer.

Learn more: Home Equity Loan vs. HELOC: What's the Difference?

Cash-Out Refinance

A cash-out refinance is a mortgage loan that lets you replace your existing mortgage with a new, larger one and pocket the difference in cash. Ideally, your new mortgage will have a lower interest rate, but could come with higher monthly payments.

While this option can help you tap into your home's equity, keep in mind that it requires taking out an entirely new mortgage. So the process can be a bit more complicated than getting a home equity loan or HELOC. You can usually borrow up to 80% of your home's equity in a cash-out refinance over a 15- or 30-year term with a fixed or variable rate.

Pros and Cons of Using Home Equity for Remodeling

Before deciding to borrow against the equity in your home to cover remodeling costs, it's important to consider if it makes sense for your financial situation and budget. Here are some pros and cons of using home equity for home improvement financing:

Pros

• Lower interest rates: Interest rates on home equity loans, HELOCs and cash-out refinances are often lower than on credit cards or personal loans because your home serves as collateral for the loan, reducing the lender's risk.
• Potential tax deductions: The mortgage interest you pay annually may be tax deductible when you use home equity for certain types of home repairs and major renovations.
• Builds more home equity: Home renovation projects often have a strong return on investment (ROI), so investing in upgrades may increase the value of your home.

Cons

• Risk of foreclosure: Home equity loans, HELOCs and cash-out refinancing are secured loans that use your house as collateral. If you're not able to keep up with payments, you could lose your home.
• Closing costs and fees: Most lenders charge closing costs of 2% to 6% of the loan amount. There may also be fees, such as appraisal fees and loan origination fees.
• Adds to debt: If you borrow more than you can afford or your financial circumstances change, you may find yourself over-leveraged with too much debt.

Learn more: Should You Tap Into Your Home Equity?

Should You Use Home Equity for Remodeling?

You can typically spend home equity funds on nearly anything, including debt consolidation. But it often makes the most financial sense to reinvest the money you borrow from your home toward fixing it up and adding more value.

Here are a few situations where it may be a smart move to use the equity in your home to pay for remodeling expenses:

• You're tackling high-ROI projects. Using home equity is generally best for projects where you expect to see a larger return on your investment. For example, upgrading your HVAC and replacing your garage door typically have ROIs over 100%, but a mid-range bathroom model might only return around 70%.
• You have significant equity and low debt. To qualify for home equity financing, most lenders require that you have at least 15% to 20% of home equity and a low debt-to-income ratio (DTI). If you're within these sweet spots, using home equity could be a good option to finance home improvements.
• You plan to stay in the home long term. Whether you're doing an addition or upgrading your roof, if you don't have plans to sell your home anytime soon, investing in home improvements can bring improved quality of life for many years to come.

Tip: Tapping into your home equity when interest rates are high could be an expensive move—you could pay a high rate while at the same time losing some of the valuable equity you've built. Weigh the costs against how much value your home could gain with a remodel before committing to a new loan.

Tips for Using Home Equity to Remodel

Using the equity in your home to cover the cost of remodeling can help you make your home a nicer place to live or drive up the value when it's time to sell. Consider these tips if you plan to use home equity to remodel:

Determine Your Equity

You can calculate your home's equity by subtracting your mortgage balance from your home's market value. While the market fluctuates often, websites like Zillow, Redfin and Realtor.com can give you a ballpark estimate of your home's worth. Just keep in mind that if you decide to apply for financing, lenders typically require a professional appraisal to determine your home's actual market value.

Set a Realistic Budget

Before you can use home equity to pay for a project, you need to know the cost. First, determine what renovations you want (or need). Are you planning a kitchen remodel? Upgrading your windows and siding? Or maybe you're hoping to tackle a dream project, like adding an in-law suite.

Next, get quotes from several different contractors for comparison. Be sure estimates include materials, labor, permits, inspections and any other project costs. If you're planning to handle some of the work yourself, don't forget to include the cost of supplies, equipment rentals and other things you'll need to get the job done.

Choose Your Financing

Once you know how much equity you have in your home and how much you need to borrow, it's time to compare home equity financing options. Carefully review the unique advantages and disadvantages that come with home equity loans, home equity lines of credit or cash-out refinancing.

For example, consider a home equity loan versus a HELOC. A HELOC has a variable interest rate, and you can borrow as needed. But a home equity loan has a fixed rate and you get the funds in one lump sum.

Work With Professionals

Hiring a qualified contractor can help you get the best value for your investment. In addition to comparing quotes, ask for references, check out reviews and look at photos of similar projects. Before work begins, be sure you have a detailed remodeling contract that includes information about a project scope, timeline, payment schedule, warranties and how to handle dispute resolution.

It's also important to check your contractor's credentials to make sure they're legally and safely able to complete the work. Be sure professional licensing, insurance and bonding are all valid and up to date before allowing contractors into your home.

Alternatives to Using Home Equity for Remodeling

When it comes to paying for home improvements, if you don't want tap into your home's equity there are plenty of other options, including:

• Cash savings: Whether you set up a sinking fund for home improvements or only need a few hundred bucks to buy some new plants for the yard, the money in your savings account can help pay for home-related costs. Keeping a flush emergency fund for unexpected costs like replacing your refrigerator or repairing a leaky roof can help you avoid taking on additional debt.
• Credit cards: Getting a new credit card might be a good option for smaller DIY projects, especially if you buy supplies with a credit card that offers an introductory low or 0% annual percentage rate (APR) on purchases. Whether using a new card or one in your wallet, make a plan to pay off the balance quickly to avoid costly interest charges.
• Personal loans: Homeowners commonly use personal loans to make improvements. They're typically unsecured loans, meaning there's no collateral tied to the loan, and you pay back the loan in fixed installments. The trade-off: The interest rate is typically higher than with home equity options.
• Government grants: Homeowners can use government grants to pay for certain types of essential home repairs. Different types of grants are available at the federal, state and local levels. But eligibility requirements are strict, and it's often competitive to get funding.

The Bottom Line

Remodeling your home can not only make it a nicer place to live but can also drive up the value when it comes time to sell. But paying for home repairs can be expensive. If you qualify, using the equity in your home may be a good option to financing home improvements. Home equity loans, HELOCs and cash-out refinancing are all solid choices—if they make sense for your budget and financial situation.