How Does a Home Equity Loan Work for Home Improvements?

Does your home need repairs? Paying for home improvements out-of-pocket can be costly. However, the solution may be right under your roof — you can finance your home improvements with a home equity loan. Learn how this type of loan can help you fund a home improvement project.

What Is a Home Equity Loan?

A home equity loan is a one-time loan that lets you use your home’s equity as collateral. Your home equity is the portion of your property that you actually “own” — it’s the current appraised value of your home, minus any outstanding loan or mortgage balance.

For example, if your home is valued at $300,000 and you have $100,000 remaining on your mortgage, then you have $200,000 of home equity. The less you owe on your mortgage, the more home equity you have.

You can get a loan for up to 85% of your property’s value. With a home equity loan, you will get a lump sum amount that you can use to carry out any home improvement projects.

Why Use a Home Equity Loan for Home Improvements?

Whether you have to make repairs or you want to upgrade your home for other reasons, home improvements are a big investment. Many people use home equity loans when they can’t afford to pay for these improvements with the cash they have on hand.

This type of loan lets you renovate your home without having to pay directly out of pocket. Plus, because it is a secured loan, the lender carries less risk, which translates to you getting a lower interest rate. Another reason to use a home equity loan is to find a payback plan that fits your budget and the timeline you need. 

Home Equity Interest Rates

Home equity interest rates rise and fall in accordance with market conditions. In addition, your credit score, regular income, and the size of the loan you’ve requested will all factor into your initial interest rate.

The average fixed home equity loan rate for a 10-year period is 5.67%, and for a 15-year period, it’s 5.63%. Meanwhile, for a home equity line of credit, the rates are generally variable. Although variable rates generally start out lower, they can shift depending on market conditions, which makes it more difficult to predict how much you’ll spend over the life of the loan. You may be able to find a HELOC with a fixed rate, but that is rare.

How Does a Home Equity Loan Work for Home Improvements?

Before you look for a home equity loan, you need a cost estimate for your home improvement project. To get an accurate estimate, contact a contractor to ask how much they would charge for your planned home renovations. Next, compare that estimate to how much home equity you currently have. The lender will then hold your home as collateral for this loan.

You will have to repay the borrowed amount along with interest on a repayment schedule over a defined period, which can be 10, 15, 20, or 30 years. Should you default on your loan repayment, the lender can foreclose on your home.

What Can You Use a Home Equity Loan For?

You can use a home equity loan for making big or small home renovations, such as:

  • Remodeling a kitchen
  • Redoing a bathroom
  • Adding a new home office
  • Adding a new master suite
  • Changing the roof
  • Changing the windows and doors
  • Redesigning the ceilings
  • Getting new furniture

How To Apply for a Home Equity Loan

To get a home equity loan, you can get started by filling out the details in an online application through a potential lender. You will need to fill in personal and financial information, which would include name, address, salary, and the loan amount needed.

Tax Benefits

If you’ve used your home equity loan to improve your home, then your annual interest payments may be tax-deductible. If your home loan debt is below $750,000 (or $375,000 for homeowners who are married but filing separately), then you may be able to deduct your interest payments for your annual taxes. To find out the impact of your home equity loan on your taxes, contact a licensed tax professional.

Requirements for a Home Equity Loan

To get a home equity loan for renovations, you need to have documents that verify these conditions:

  • A loan-to-value (LTV) ratio that is no more than 85% of your home equity
  • A good credit score (680 or higher)
  • Proof of sufficient income
  • An overall debt-to-income ratio (DTI) no higher than 43%
  • A reliable payment history

Home Equity Line of Credit (HELOC) 

An alternative way to use your home as collateral for home renovations is with a home equity line of credit. A HELOC works as a revolving credit line, like a credit card, with a set maximum borrowing limit. Within an agreed-upon draw period, you can borrow from this credit line as many times as you want until you reach that limit. You only have to repay what credit you use.

Similarities between a home equity loan and a HELOC:

  • They both use your home as collateral.
  • Both are useful for investing in home improvement projects.
  • They both have lower interest rates than other types of loans.

Key differences:

  • A home equity loan is disbursed as an upfront lump sum, while a HELOC is a credit line you borrow from as needed.
  • A home equity loan has a fixed interest rate, while a HELOC charges a variable interest rate.
  • With a home equity loan, your monthly payment is based on the lump sum you borrowed, and with a HELOC, your monthly payment is only for the credit you use.
  • With a home equity loan, you make monthly payments on the borrowed amount plus interest at your fixed rate. With a HELOC, you make interest-only payments on any money borrowed during the draw period. During the repayment period, your monthly payments include principal plus interest.

Benefits of Using Home Equity Loan for Home Improvements

There are many benefits from a home equity loan for marking home improvements:

  • The investment may increase your home’s value.
  • Interest rates on home equity loans are lower than on personal loans or credit cards.
  • A home equity loan has tax deduction benefits.
  • A long repayment period makes it an attractive financing option. 

A Different Way to Unlock Your Equity

While a home equity loan is one option for financing a renovation, another option would be a home equity investment from Point. You get cash for your home improvement project in exchange for a share of your future home appreciation. Unlike with a home equity loan, you won’t have to make any monthly payments. Instead, you can repay the amount (plus a percentage of the increase in your homes’ value) at any time during our 30-year term,  through a home sale, refinance, or another source of funds. 

If need funds for a home improvement project, see if you qualify for our HEI instead of a home equity loan. Get the cash you need without the monthly payments.

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