Using a home equity loan for your remodel: What to know

It’s common for expenses to pop up that require financing. If you don’t have enough cash on hand, you may be able to fund major expenses with personal loans and credit cards. Homeowners, however, have the unique opportunity to use the equity in their home to gain access to financing. These loan options include cash-out refinances, home equity loans and home equity lines of credit (HELOCs).

Here, we’ll focus on home equity loans. Is it possible to use home equity loans for remodels? And how does this option compare with the others?

Can you use a home equity loan for a remodel?

Yes, you can use a home equity loan for a remodel or renovation by tapping into the home equity you’ve built and using it as collateral for a loan. There are several other ways to use a home equity loan, like paying off credit card debt, starting a business or covering college tuition.

Typically, there aren’t restrictions on how you can use this money. But home improvements can be a wise investment of these funds because you can get a return when you resell the home later on.

How does a home equity loan work for home improvements?

A home equity loan allows homeowners to use the equity they’ve built up in their homes as collateral. If they decide to take out a home equity loan, they’ll have a lump sum payment they can use in whatever way they choose. This includes remodeling their home.

Homeowners who take out a home equity loan make monthly payments on the loan in addition to their mortgage payments. The monthly payments are made up of two items: principal and interest. The principal is the original amount that was taken out for the loan. The interest on the loan is fixed, meaning your loan’s interest rate won’t increase over time. So during the repayment period, you’ll be paying off the principal and any interest that has accumulated.

It’s also important to note that home equity loans use the home as collateral for the loan. This means if the homeowner is unable to repay the loan, their house can be foreclosed on.

An example of using a home equity loan for home renovations

First, homeowners need to qualify for a home equity loan. Lenders will assess the borrower’s equity, credit score, and debt-to-income ratio. Provided a homeowner qualifies for a home equity loan, lenders will then use a loan-to-value ratio (LTV) to determine how much a homeowner would qualify for.

For example, let’s pretend your home was recently appraised at $500,000 and you still owe $100,000. Rocket Mortgage^® would allow you to borrow about 90% of the equity you’ve built into your home. To determine what that would be, you would subtract whatever you owe on your mortgage from 90% of the appraised value on your home:

$500,000 x 0.9 = $450,000

$450,000 - $100,000 = $350,000

So, the maximum amount you could obtain with a home equity loan would be $350,000. Once you receive the loan, you’d be able to begin your renovations.

The pros and cons of home equity loans for remodels

Like anything in life, there are pros and cons to using a home equity loan for home improvements. When considering whether a renovation home equity loan is right for you, it’s important to consider the following pros and cons with your financial situation in mind.

4 tips for using home equity loans for remodels

There are plenty of ways to make sure you’re getting the most value out of your remodel and home equity loan. The best ways to make sure you’re getting your money’s worth are below.

1. Determine if your project adds home value

Whether a remodel financed by a home equity loan is worth it depends on whether the project adds home value. Some home improvements can increase a home’s financial value and your overall satisfaction with it. The best home improvements in this respect are the ones that don’t pass the costs of upkeep onto new owners. These include things like installing hardwood floors and new garage doors.

There are many home improvements that don’t add value. These often result in additional fees, upkeep or extra care for new owners. Take pools and hot tubs as an example. For some families, they’re the perfect way to beat the heat or relax. For others, the cost of maintenance, permits and concerns about safety make families less willing to purchase your home. You should also avoid renovations that are over-personalized or customized to your lifestyle, because a buyer likely won’t pay more because of them.

2. Establish a budget before applying

Before starting any project, it’s important to determine how much your remodel will cost. It’s best to do this before applying with a lender so you know if a home equity loan will cover your expenses. A home renovation budget helps you determine the scope of the project and the materials you want to use.

Additionally, having your budget prepared allows you to cut some of the costs associated with working with a contractor. Before your project begins, you’ll meet with your contractor team. Having your budget prepared cuts down on the hours you’ll spend with the team, which saves you money on the cost of labor.

3. Factor in unexpected expenses

You also need to budget for unexpected expenses. You don’t want your budget to be spread too thin. Anything can go wrong or get delayed, so make sure you have the funds on hand if something happens. If your house is old, be prepared to find out you need further modifications to keep your house up to code.

There are also other expenses you need to consider aside from just materials and labor. You’ll need to account for extra costs like taxes, delivery charges, permit expenses, etc.

4. See if you meet the requirements for home equity loans

Before you apply for a home equity loan, check to make sure you meet the requirements. You must meet guidelines regarding credit score, debt-to-income ratio (DTI) and current home equity. These will impact how much you can borrow.

Guidelines may vary by lender, but here are the basic requirements at Rocket Mortgage:

HELOCs vs. home equity loans for remodels

A home equity line of credit (HELOC) also allows for homeowners to borrow against the equity they’ve built into their home. But, unlike a home equity loan, HELOCs distribute the funds you receive as a line of credit instead of as a loan. Basically, a home equity loan provides you with a lump sum while a HELOC provides you with the funds as you need them.

HELOCS are made up of a draw period and a repayment period. During the draw period, your line of credit is open and available for use. You can borrow from it as needed, and you’re only required to make payments to cover the interest on your loan. Once the draw period ends, you enter the repayment period and begin to pay back principal and remaining interest.

When considering using a HELOC versus a home equity loan for home improvements, there are several pros and cons of HELOCS to consider:

Alternatives to home equity loans for remodels

If using a home equity loan for renovations is not the right choice for your financial situation, fear not. There are numerous other home improvement loans and financing options available.

Cash-out refinance

A cash-out refinance allows you to use some of the equity you’ve built in exchange for cash. When considering a cash-out refinance versus home equity loan, it’s important to consider several factors:

• Cash-out refinances tend to have the lowest interest rates of standard ways to borrow money.
• A cash-out refinance results in a new mortgage, while a home equity loan means an additional payment on top of your preexisting mortgage.
• If interest rates are high, using a cash-out refinance could result in you paying more in the long term. This is because you refinance your entire mortgage, not just the amount you want to borrow.

Personal loans

Personal loans, like home equity loans, are also given in a lump sum, but they’re not backed by anything as collateral. As a result, they tend to have higher interest rates. These loans are assessed based on a person’s credit score, income and debt-to-income ratio. When considering personal loans versus home equity loans, keep in mind:

• Personal loans tend to be processed faster since there isn’t a home appraisal required to qualify.
• You don’t need to own a home or have sufficient equity, and you can access the funds immediately, sometimes on the same day you submit your application.
• You need to have extremely good credit to qualify for a personal loan with a lower interest rate.
• Repayment periods are usually shorter with more severe penalties for late payments and other issues.

Credit cards

If you’re interested in minor updates for your home, you may just want to finance them with a credit card. Many cards come with rewards for using them. However, you would have to pay everything back by the end of the billing cycle to avoid getting caught in the trap of high interest rates and credit card debt.

Savings

It may take a while to save up the money, but it’s possible to completely finance the project on your own. When using your savings, it may be better to start with smaller, less expensive projects that’ll help build up home equity so you can finance larger ones. However, financing the project yourself could take more time and potentially delay the project, especially if an issue arises and you’re completely responsible for the finances. Additionally, if there’s an emergency or you go over budget, you may not be able to factor everything in.

The bottom line

There are numerous ways to finance your home remodeling project, and home equity loans are a strong option. Home equity loans are repaid in fixed monthly payments, tend to have lower interest rates and longer repayment periods, and are a great way to fund a home improvement project that can build your equity.

If you’re considering a remodeling project and want to use a home equity loan to invest further into your home, fill out an application for a Home Equity Loan with Rocket Mortgage today.