How to Use Home Equity to Fund a Home Renovation

Article Summary:

If you have a lot of equity in your home, one of the best ways to make use of that money is to finance home improvement projects. Not only will you increase the market value of your house, but you can also make your home a more energy-efficient and pleasurable place to spend your time. There are several ways to go about harnessing your home equity. Some of your best options are to go with a home equity line of credit, a cash-out refinance, a shared equity agreement, or a home equity loan.

When the pandemic hit in March of 2020, many people were forced to work from home. Since then, for a variety of reasons, that trend has continued, which means many homeowners are now using their residence as their primary office space as well.

This has caused some to question how to better utilize the space they have available to them or whether it’s time for an upgrade. Home improvements can make that transition easier to manage or as a means to elevate the value of the home to sell and look for something better.

Leveraging your home’s equity, through home equity loans or other possibilities, are ways to achieve either goal. First, let’s take a look at ways to specifically increase your home’s value through home renovation projects.

Home improvements to increase value in the home

There are dozens of ways to remodel your house either to balance your work and home life or to get it ready to sell. If you’re already in your dream home and just want to improve upon it, the sky’s the limit. But if you’re looking to sell and get a better price, there are specific renovations to consider before you set your budget and get to work.

You might start by talking to a real estate agent to find out what buyers want, or looking at home listings and notice how they’re worded. (Real estate descriptions are practically a different language.)

You might start noticing some trends that will give you an idea of what new homebuyers are looking for in a house, such as an updated kitchen or newly renovated bathrooms. Energy efficient appliances, a new roof, and double-paned windows are always pluses as well.

Kitchen and bathroom remodels

Bathroom or kitchen remodeling projects are two excellent ways to add value to your home. The kitchen, after all, is often the heart of a home, and buyers don’t want to see dated appliances, linoleum flooring, or flimsy cabinets.

Kitchen or bathroom renovations can be expensive jobs, but they add a lot of value to the home as well as improve its walk-through appeal.

Basement or attic renovations

Maybe you want to turn the attic into a state-of-the-art home office or another bedroom or, if you’re planning to sell, even just a finished space known as a “bonus room.” Buyers like to see areas where they can envision putting on their own stamp of individuality. An accessible space could be a work-out room, children’s play room, media room, or any number of other possibilities.

Finished basements are another great way to add some significant living space without going to the enormous expense of putting on an addition. Install a wet bar, a pool table, and a great entertainment system, and you’ve got the makings of a great party room.

Curb appeal projects

As you make improvements, don’t neglect the outside of your home. After all, the exterior of your house is the first thing prospective buyers see.

Some of the work you can even do yourself. Keeping the grass cut, trimming bushes, giving the siding a good scrub, and slapping a new coat of paint on that white picket fence all make your home look more appealing.

More expensive projects include new siding, windows, or doors — maybe even a new roof. None of these improvements come cheap, but they will raise the value of your home and attract more buyers.

How do you build home equity with home improvements?

Most improvements that you make to your house will cause it to increase in value, which therefore builds your equity. But be careful of exactly what you do.

For example, you may think putting in a pool is the height of luxury and will increase your home value by thousands. However, some buyers may see it as a liability. The upkeep on a pool is expensive and time-consuming and may actually turn a number of potential buyers away.

Accessing your home equity for home improvements

There are several ways to take out your home’s equity to make improvements to your dwelling. Picking which option is the right one for you depends a lot on the amount of equity you have, the current value of your home, your income, and what your credit report reveals about your history of paying back debts.

Depending on your overall financial situation, there are many possibilities to think about before deciding which one best fits your needs. You may even want to talk to a financial advisor first to go over your options.

Don’t forget that many of your options will be secured by your home as collateral, so you’ll also want to carefully weigh the pros and cons of having your primary residence at risk if you can’t make your minimum monthly payments. Plus, you will likely have to pay closing costs as well, which can take a bite out of your home improvements budget. Be sure to factor in that plus other costs and fees associated with taking out any kind of loan.

In any case, as you look into the best ways to leverage your equity for home improvements, be sure to compare multiple lenders to find the best deal.

Pro Tip

If you don’t need to start your remodeling project right away, consider taking a little time to work on improving your credit score. The better your credit report, the greater chance you’ll have of getting more favorable loan terms.

Home equity line of credit

Perhaps one of the ideal methods of using your home equity to finance home improvements is by taking out a home equity line of credit (HELOC). This is especially true if you plan on taking your time with the renovations —and perhaps doing some of the work yourself — as opposed to doing a massive overhaul.

Because a home equity line is a revolving line of credit, where you can borrow as much or as little as you like for the draw period (usually ten years), you won’t need a lump sum of money all at once. Plus, you don’t need to start paying it back right away — during the draw period you can make interest-only payments.

Remember that home equity lines of credit usually come with variable interest rates, which means monthly payments can be unpredictable. Keeping that principal balance under control is particularly important in this scenario.

How to use a HELOC for home renovations

To maximize your HELOC and minimize the interest paid, you might want to rethink your repayment strategy. For example, if you want to start by putting on a new roof in the fall, you could use your HELOC to pay for that, and then work on paying it off over the winter.

Then in the spring might be a good time to draw some more money from your line of credit to start renovating a bathroom. After you’ve paid off a substantial portion of the bathroom work, you can move on to the kitchen or basement, and so on as you work your way through your list of home improvement projects.

The flexibility of the HELOC allows you to take your time, make decisions, and change your mind as you go along. This is a solid idea for people who know they want to put some work into their home but don’t necessarily have a clear-cut plan for the big picture.

Home equity loan

Home equity loans, on the other hand, are more suited to home improvement enthusiasts who have a clear plan for their renovations and want to do it all in a relatively short period of time. A lump sum payment, which is how a home equity loan is disbursed, is more appropriate in this case. You will need that money in the short-term to pay for contractors, subs, and materials in a timely manner to ensure the work moves along as planned.

For example, if you want to sell your house within the next year or so, but the kitchen and powder room could really use a facelift, you’ll want to complete those remodeling projects as efficiently as possible to prepare the house for prospective buyers.

Unlike a HELOC, a home equity loan is considered a second mortgage, which means you will need to start making monthly payments right away. However, also unlike home equity lines of credit, home equity loans have a fixed interest rate. This makes your loan payments predictable every month throughout the repayment period.

Shared equity agreement

A shared equity agreement is a bit of a different animal and, while technically not a loan, it does allow homeowners access to the equity in their homes without the need for especially good credit or a large income. This equity option is also a good choice for homeowners looking for a relatively large amount of money for home improvement, either to put it up for sale or for their own enjoyment.

Shared equity agreements are basically a deal between you and an investor who agrees to give you a lump sum of money in exchange for future equity in your home. It’s not entirely unlike playing the stock market where an investor buys a share of a company in hopes that its stock price will rise and make a profit down the road when it’s sold.

It’s a safer bet than the market, though, because houses generally appreciate. However, the investor also takes on the risk that they could lose money in the deal if the house has depreciated at the end of the term or when the house is sold.

In this case, though, because the plans for the funds are to finance home improvement projects, there is a better than average chance the house will gain in market value and everyone will profit. Your purpose for giving up some future equity should also increase your chances of finalizing the agreement.

Cash-out refinance

Your final option, and possibly the most difficult to achieve, is cash-out refinancing. This option involves getting a new and bigger loan to pay off your outstanding mortgage balance and taking a check for the difference. Depending on your exact financial situation, this might be a good choice if you want to make some major home improvements but do not plan on selling the house.

A cash-out refinance can be harder to get because you’re applying for a larger loan than your original mortgage. This means you’ll need to have a good credit score (if not excellent) and show sufficient income to make the bigger monthly payments.

A cash-out refi, like a home equity loan, comes with a fixed interest rate, but it also might be a higher interest rate because of the size of the loan. Also, the fact that it’s an entirely new loan means you will be on the hook for closing costs and likely other fees as well.

Alternative financing options for home renovations

If you don’t have a lot of equity in your home or your efforts to tap into it haven’t panned out, there are a few other choices to pay for your house improvement projects.

Savings

If you’re planning on selling soon, and you’ve exhausted lending options, it’s not a bad idea to take some of your savings and pour it into home improvement. If you choose your projects wisely, you should be able to recoup your savings and then some as soon as you sell.

Credit cards

Credit cards usually come with high interest rates, which means it’s not usually a good idea to use them for home improvement expenses. But, like with your savings, if you’re planning on selling the house soon, it might make sense.

Once you sell, you can pay off the credit card balance and pay minimal interest. Even better, if you can get approved for a card with a 0% introductory interest rate, you can ideally pay that card off before the balance even starts to accrue interest.

Personal loans

A personal loan is another common way to pay for home renovations, and the interest is typically much lower than your credit card. This could be a viable option for you whether you plan to sell, just want to update your bathroom, or build out that attic into a sweet home office set-up.

Loan against retirement money

Your parents probably told you that borrowing money against your retirement savings is a big no-no. And, to be honest, it should probably be considered a last resort when it comes to renovating your home. After all, you’re taking away from the interest you should be earning for a comfortable retirement.

Having said that, taking a small loan against your pension could help you to make some improvements on your home to get it ready for sale, which ideally you’ll put right back into your retirement account.

Pro Tip

When calculating your home improvement costs, factor in roughly 10% to 15% more than you think it will cost. Construction projects often go over budget — plus you might change your mind about certain projects as you go through the process.

FAQs

Is a HELOC tax deductible?

As long as you use the loan funds from home equity loans or HELOCs for home renovations, the interest is tax deductible just like with your current mortgage. You cannot deduct the interest if you use the money for other things like buying a car, paying off credit card debt, or paying for personal living expenses.

Can I pay off a HELOC early?

You most certainly can pay it off early, and that should be your goal if at all possible. The sooner you pay off any money you borrow, the more you will save on interest payments. And because a home equity line of credit has a variable interest rate, the smaller the principal, the more manageable your payments will be.

Key Takeaways

  • Using your home equity to finance home improvements is a great way to increase the value of your home using money you’ve already built up in the house.
  • There are four basic ways to access your home equity — a HELOC, cash-out refi, home equity loan, and a shared equity agreement.
  • A home equity line of credit might be best for homeowners who want to take their time renovating. On the other hand, a home equity loan or other loan products are best if you need a lump sum of cash.
  • A HELOC comes with a variable interest rate, whereas a cash-out refinancing and home equity loan have a fixed interest rate. A shared equity agreement has no interest rate because it’s not technically a loan.
  • You have some other options for making home improvements if you don’t have a lot of equity in your home or aren’t able to access it.
View Article Sources
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  2. Risk Management of Home Equity Lines of Credit Approaching the End-of-Draw Periods: Interagency Guidance — Office of the Comptroller of the Currency
  3. What is a home equity loan? — Consumer Financial Protection Bureau
  4. How to Tap Into Your Home Equity Without Getting Into Debt — SuperMoney
  5. How To Get Equity Out Of Your Home — SuperMoney
  6. Best 10 Money-Making Home Improvements for 2022 — SuperMoney
  7. Home Equity Loan vs. Line of Credit: Which Should You Choose? — SuperMoney
  8. Reverse Mortgage vs. Home Equity Loan vs. HELOC: Pros & Cons — SuperMoney
  9. Home Improvement Financing: How to Finance a Home Renovation (Updated 2022) — SuperMoney
  10. Are Home Improvement Loans Tax Deductible? — SuperMoney
  11. Best HELOC Lenders | July 2022 — SuperMoney
  12. Best Shared Equity Agreements | July 2022 — SuperMoney