A home equity loan, often called a second mortgage, allows you to borrow against the equity you’ve built in your property. These types of loans provide a lump-sum cash deposit you can do anything with, including remodeling your home. This is in contrast to a home equity line of credit (HELOC), another type of second mortgage. A HELOC functions sort of like a credit card; you’ll charge purchases to your line of credit and pay off the amount you use once the loan period ends.
Let’s take a look at the pros and cons of using a home equity loan for a remodel, when it makes sense to do so, and how to go about using a home equity loan wisely.
- Home equity loans tap into the equity you’ve built in your property.
- You can increase the resale value of your home by remodeling it with a home equity loan.
- Interest paid on home equity loans used for remodeling is tax-deductible.
- Home equity loans can offer a lower-interest option to financing a remodel.
Pros and Cons of Using a Home Equity Loan for a Remodel
Lower-interest method of financing a remodel
Can increase the value of your home
Interest paid is tax-deductible
You may need to pay closing costs
The remodel may not recoup your costs
You’ll owe interest
- Lower-interest method of financing a remodel: There are many different ways to finance a remodel, but using a home equity loan for a remodel can save you money in interest compared to using a personal loan or credit card.
- Can increase the value of your home: Using a home equity loan to remodel your house can make your property more valuable, especially if you choose an option that provides a high return on investment (ROI).
- Interest paid is tax-deductible: Home equity loans that are used to remodel your property allow you to deduct any interest paid on your taxes.
- You may need to pay closing costs: Depending on your lender, you may be on the hook for closing costs on the home equity loan, including origination fees and appraisal fees.
- The remodel may not recoup your costs: This is most important if you’re remodeling for resale; choosing a poor investment may mean you won’t be able to get back much of the money you’ll pay.
- You’ll owe interest: Anytime you borrow money, you’ll need to pay interest. Your interest rate will depend on a number of factors, including your lender, credit score, and the market value of your home.
When It Makes Sense To Use a Home Equity Loan for Remodeling
Using a home equity loan to remodel your house can be a good idea if you’re looking to increase the value of your property. Typically, remodeling can be a reliable method to do so, especially if you pick your projects carefully. Some changes can recoup as much as 93% of the money you’ve paid in value.
However, if you’re choosing to get a home equity loan because you otherwise can’t afford a remodel, you may want to consider your situation more carefully. You’ll need to repay the loan, plus interest, and if you’re already struggling, the payments may become unmanageable. This is even more pertinent with some specific loans; those that allow interest-only payments may have a much larger balloon payment at the end of the loan term.
How To Use a Home Equity Loan Wisely
Tapping into your home equity can be a wise option, but be sure you’re using the loan correctly.
Beware of Overspending
Depending on how much equity you have in your property, you may be able to get a very large home equity loan. However, just because it’s there, doesn’t mean you have to spend it. Choose your renovations, assess the budget you’ll need, and stick to it. Don’t spend all your money on unanticipated upgrades—remember, you’ll be paying interest on every penny you spend.
Many lenders prefer you don’t borrow more than 80% of the value you have in your home.
Pick the Right Projects
Although tearing down that spare bedroom to make yourself a large master suite may be your dream, use discretion when planning improvements. Not all projects will add value to your property, and if you’re ever looking to resell, you’ll want to keep this in mind.
Stick to a Remodel
Home equity loans aren’t tied to remodeling projects; in fact, you can use the money for almost anything you’d like. But you’re only able to deduct the interest you pay if the loan is used to buy, build, or substantially improve your home that secures the loan.
Deduct Your Interest
Be sure you’re correctly deducting the interest you’re paying on your home equity loan. You’ll need to file an itemized tax return rather than taking a standard deduction, but this may be worth it—even more so if your home equity loan is large.
Frequently Asked Questions (FAQs)
How much can I borrow if I want to remodel with a home equity loan?
Many lenders prefer you keep a combined loan-to-value ratio (CLTV) of less than 80%. This means that the total amount of all of your mortgages needs to be 80% or less of the value of your property.
How long does it take to get a home equity loan?
The length of time it takes to close on a home equity loan will depend on your lender, but expect that it will take around 45 days.
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