Relying on Equity for Home Renovations?
In many cases, home improvements, when done correctly can add to the overall value of your home. They can, of course, also be quite expensive, leaving many homeowners wondering how to finance their new roof, updated bathroom, or backyard paradise.
While paying out of pocket is ideal, it’s not always a feasible option for homeowners, especially if it means depleting or taking a significant chunk out of your savings or emergency funds. However, the nature of the project — putting money back into your home — often makes home equity-based financing a good choice.
Home equity is just one benefit of owning a home; you may want to consider putting that benefit to work. With a home equity loan, you can borrow against the existing equity, or the difference between the market value and your existing mortgage balance.
What Home Equity Products Are There?
If you are considering home equity financing, then you’ll need to choose between two products: a home equity loan or a home equity line of credit (HELOC).
Home Equity Loan Vs. Home Equity Line of Credit.
Home equity loans and HELOCs share similarities. For example, both require that the borrower own at least 15 to 20 percent of their home, and limits are typically set to no more than 80 to 90 percent of the equity amount. However, there are significant differences that may make one more suitable for your needs.
Rates
Home equity loans carry fixed interest rates, while HELOCs, notably carry variable rates, which fluctuate over the course of the loan. In some cases, however, HELOCS will offer lower rates, this depends on the prime rate.
Funding
A home equity loan is a one-time, lump sum, while a HELOC is considered revolving debt. In the case of a HELOC, you will gain access to a line of credit with a spending limit. You can borrower against it at any time during the draw period, which is usually around ten years. You are only required to make payments on the amount borrowed, not the amount you were approved.
Repayment
Home equity loans are term loans with fixed, monthly payments – you’ll always know exactly how much you owe. HELOC payments are determined by the total amount borrowed and the variable interest rate applied. However, some lenders allow borrowers to transition to a fixed payment plan during the repayment period, though that’s not a guarantee.
Picking Between the Two
When to consider a home equity loan
- You know exactly how much you need to borrow.
- You prefer a fixed monthly payment.
- You have a history of poor money management and therefore may not want to risk ongoing access to funds as is offered by a home equity line of credit.
When to consider a HELOC
- You’re not sure how much you need to borrow (e.g., a multiphase project).
- You want access to funds over a long period of time.
- You plan on using funds in small amounts and therefore can likely pay down the balance quickly and limit the amount of interest accrued.
Positive Benefits of Using Equity
There are numerous benefits to using your equity to finance your home renovations, including the following:
- Home equity loans and HELOCS can carry lower interest rates when compared to other financing options like personal loans or credit cards.
- As secured debt, they may be more accessible and affordable for borrowers who have average or below average credit.
- Borrowing against your equity can allow you to make home improvements that add to the total value of your home, therefore increasing your return on investment.
Drawbacks of Home Equity
If you’re considering a home equity loan or HELOC, it’s important to consider the following risks.:
- Home equity loans and lines of credit are considered secured debt. Failure to pay can result in foreclosure.
- Depending on the nature of your home renovations, the existing interest rates, and the housing market, you may find that equity-based financing can leave you owing more on your home than its actually worth.
What Are Some Alternatives to Home Equity Solutions?
Though equity can be a useful tool in financing home renovations, it’s not the only one available. You may also want to consider the following:
Credit Cards
If you have good credit and can secure a low-rate intro offer or a high signup bonus on a credit card, you may be able to finance your home improvements on revolving credit. If you get a low rate offer, you could avoid interest, or if you get a high signup bonus, you may be able to get cash back on your home improvement. Of course, relying on a credit card also poses risks. if you’re using this type of financing, you must be confident you can pay off the balance prior to the promotional end date. You may get stuck with a high rate if you miss the promo date.
Personal Loans
Personal loans may carry slightly higher interest rates, but if you don’t have enough equity in your home to secure a home equity loan or HELOC, they may be the next best option. In addition, many personal loans are unsecured; therefore, you do not have to put your home up for collateral.
If, however, you have average or below average credit, you may find that a personal loan is harder to secure or that it carries significantly higher interest rates.
Cash Out Refinancing
Cash-out refinancing is another equity-based lending product. This option requires you to remortgage your home for an amount higher than the balance owed, and you’ll receive the cash difference between the two numbers. If interest rates are low, this can be a good option; however, if interest rates are higher than your existing mortgage, it can be a costly solution.
Bottom Line
Leveraging your home equity to make home improvements can help you improve and add value to your home. In many cases, it will allow you to take advantage of lower interest rates. However, though both a home equity loan and a HELOC can provide access to funds, it’s important to choose the one that is best for your home improvements needs and financial habits.
Sent in by Andrew Rombach from LendEDU
photo courtesy of Reader’s Digest