Using Your Home’s Equity for Home Improvements
Home improvements can take many different forms, from major projects like building an addition to smaller ones like a few new appliances. Many times, people turn to home equity products like home equity loans or home equity lines of credit to finance their home projects. This is usually a smart financial move as home equity products typically carry a lower interest rate since they are secured by the value of your home.
What type of loan is best for home improvements?
You may have smaller projects for which you don’t want to tap into your home’s equity. For example, if the only project you want to tackle is refacing your kitchen cabinets, a Personal Loan may be a better option. But for many home improvement or renovation projects, the cost will surpass what you may be able to fund via a personal loan. Rather than turn to high interest rate credit cards, your home’s equity could provide you the financing you need.
Is a home equity loan or a HELOC a better option to fund home improvements?
Both a Home Equity Loan and a Home Equity Line of Credit (HELOC) are good solutions for home improvement projects for several reasons. Both options use your home as collateral, meaning your interest rate will likely be lower than with a personal loan or credit card, which are both forms of unsecured credit. Because home improvements can be costly, you will definitely want to find the best rate possible to save on interest charges.
Determining which is a better option, though, depends on your individual needs. There are pros and cons to both so it’s important to understand what your home improvement plan is before deciding how to fund it. Will you be doing several projects over a length of time? Or are you focusing on a single larger project?
If you are planning several projects over a length of time, a HELOC may be a better option for you. Because HELOCs allow you to draw money as needed, you can access your line as your home improvement projects happen. You only have monthly payments if you use your HELOC, and often those payments are interest-only during the draw period. You can also access your line in the event of an emergency, although it’s important to resist the temptation to use it for miscellaneous expenses outside of your home renovation projects.
The draw period on a Home Equity Line of Credit is the timeframe during which you can access the funds. During the draw period, you will not need to make any payments unless you actually access your line, and often those payments are interest-only.
Once the draw period is done, you will no longer be able to take advances against your HELOC and you will begin the repayment period.
A Home Equity Loan might be a more attractive option if you have a single, large project you are going to work on, such as an addition to your home. With this option, you will receive all of your funds upfront, allowing you to pay for architects, contractors, furnishings and everything else that goes into a large home improvement project. Before applying for your Home Equity Loan, be sure to calculate all of the expenses that will be associated with your project, and build in extra for unexpected costs. Keep in mind that with a Home Equity Loan you’ll receive all of the funds as a lump sum, so you may want to set up a separate savings account to keep that money separate and earmarked solely for your project.
Is a HELOC better than a credit card for home improvements?
While some homeowners opt to charge home improvement expenses to their credit card, HELOCs are an attractive alternative. They allow you to access funds periodically - just like a credit card - but without the high interest rate. Unless you are using a card with a special zero percent or other low introductory rate, putting a large charge on your credit card will add up over time thanks to higher interest. If you do opt to use a card with an introductory rate, your goal should be to pay the balance off before that introductory rate expires. If you aren’t confident that you’ll be able to do so, or if you think you could end up adding additional charges to the card, you may want to consider a HELOC instead.
How much can I borrow for home improvements?
The maximum amount you can borrow with a home improvement loan depends on the loan-to-value (LTV) guidelines at your financial institution. At MHV, you can borrow up to 80% of your home’s value. LTV simply states the maximum percentage of your home’s value that your financial institution will allow you to borrow and is designed to protect you in the event your home’s value decreases. When you’re calculating how much you need to borrow, you’ll want to shop around to get several quotes from reputable contractors and build a budget that you’ll stick to. The chart below outlines the national average of common home improvement projects.
National Average Cost*
|Install solar panels
|Build an addition
|Install an inground pool
*Data as of 1/10/20 on HomeAdvisor’s True Cost Guide
It’s important to adjust your budget to be sure you can afford the cost of your home improvement projects. A budget will allow you to see all of your income versus all of your expenses, and allow you to adjust where you may be spending your money. Keep in mind that you don’t want to decrease your savings in order to pay for a Home Equity Loan or Line of Credit. Instead, look for opportunities where you can comfortably cut back on your spending, and determine if your estimated monthly payment will be feasible.
Use our free Budget Tool
to determine how much you can afford.
Do I qualify for a Home Equity Loan or Line of Credit?
Lenders will often look, at the very least, at your credit score and your debt-to-income ratio (DTI) before deciding to lend to you. Your credit score is a mathematical analysis of how likely you are to repay your loan on time. Your score factors in things like how many loans or credit cards you have, how well you pay your bills on time, how much of your available credit you’ve used and how old your oldest credit or loan account is. All of these factors are weighted and combined to assign you a score. It is very important to have a good understanding of what your credit score is before you begin the process of applying for a personal loan. If your score isn’t high enough, there are steps you can take to work on improving it.
DTI measures how much debt you currently have relative to your income. A DTI that is too high suggests you may be spread too financially thin to be able to make the payments on your personal loan. Even if you have a good credit score, a high DTI can cause some lenders to deny your application. Using a monthly budget tool is a great way to manage your finances and keep your debt at a manageable level.
For more information on understanding your credit, watch our brief explainer video here.
How can I save money on home improvements?
There are ways to be sure you’re making the most of your home improvement loan, and saving money on your projects. Taking the time to thoroughly plan and research your home improvement project is the single most important step you can take. Doing so will help you feel more prepared and will ensure the project goes as smoothly as possible. Here are some additional helpful tips.
- Build a strict project budget, and stick to it. It will be easy to be tempted by extras and high-end materials. Sticking to your budget will be important to keep you on the right financial path.
- Plan for the unexpected. Make sure your project budget includes about 20% of the total cost for unexpected expenses. It’s far better to build these costs in and be prepared for them than to have to find a way to come up with additional funds after your project has started.
- Think of timing. Consider doing your renovations during “off seasons” when contractors are less busy. This may save you some money.
- Shop around. It’s important to get at least three quotes from reputable, insured contractors. This will help you determine whether you can afford the project and ensure you’re getting a good deal.
- Pick your project wisely. Which will add the most value to your home? Which can you afford? Which requires the lowest amount of long-term maintenance costs?
With several options and lower rates, a Home Equity Loan or Line of Credit can put the goals you have for your home within reach.
Using your home’s equity needs to be a well thought out decision, but when faced with large or unexpected expenses, it can be the solution you need.
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