Your home equity can be a good resource if you’re looking to repair or renovate your property. One popular way to tap home equity is a line of credit (also called a HELOC). These loans have relatively low interest rates, and you can use the cash for any improvements you like.
However, they aren’t the right choice for all homeowners.
How To Use a HELOC for Home Renovation
If your renovation is ongoing or requires you to make a series of payments over time, a HELOC can be a good choice. That’s because this loan works much like a credit card. Your lender will approve you to borrow a certain limit based on how much equity you have in the property. You can pull from this line of credit as needed to fund your project.
Your HELOC will come with what’s called a “draw period”—a set period in which you can use the funds. During this period, you’ll only pay interest on the money you borrow. Once the draw period closes, you will need to start paying back the full amount used. Some lenders will allow you to do this over time, while others require a balloon payment, meaning you’ll pay the balance all at once, in full.
Before you can consider a HELOC, you’ll first need to assess how much equity you have in your home. Most lenders require at least 20% equity in your property. Most also want you to have a good credit score and a low debt-to-income ratio, although requirements will vary by lender and other aspects of your application (like how much you’re borrowing and your existing debt obligations).
Pros and Cons of Using a HELOC
The biggest advantages of a home equity line are flexibility and accessibility. If you have good credit and equity in your home, you should be able to qualify for a HELOC fairly easily.
HELOCs also come with low interest rates, especially compared to other financing options such as credit cards and personal loans. Initial payments tend to be minimal, which can be helpful if you’re funding high-cost renovations and can’t afford to pay it all off just yet.
Remember: Your home is the collateral for a HELOC, so not paying your loan off could put your property at risk of foreclosure.
Finally, the interest you pay on HELOCs used for home renovations is often tax-deductible. As long as you’re using the funds to improve the property you’ve financed, you may be able to write all or a portion of the interest off on your annual tax returns.
The downside is that most HELOCs come with variable interest rates, making payments hard to predict and budget for. On top of this, some HELOCs require balloon payments once the draw period is up. If you’ve spent a fair amount on your renovations, that could mean a hefty payment is in your future.
Interest may be tax-deductible
Allows you to draw as much or as little as necessary
Smaller payments at the outset of the loan
Can allow you to improve your home’s value
Low interest rates
Uses your home as collateral
Typically come with adjustable interest rates
Monthly payments can fluctuate
May need to pay off your full balance once the draw period ends
How To Use Your HELOC Wisely
If you’re taking out a HELOC, it’s best to use the funds only as needed. You should also consider making additional payments during the draw period (not just on interest) to prevent sky-high payments later on. And if possible, shop around for a mortgage lender that offers fixed rates, rather than adjustable ones. This can help keep your payments more consistent and easy to budget for.
Potential Tax Benefits of HELOCs
If you’re using your HELOC for home renovations or repairs that improve your property’s value, then you can deduct the interest paid on your loan. There is a limit, though. Due to the Tax Cuts and Jobs Act of 2017, you can only deduct the interest on up to $750,000 of home loan debt—which includes your mortgage and HELOC.
Other Options for Funding Home Renovations
A HELOC isn’t the only way to finance your home renovations. Be sure to consider other options you might have, like a cash-out refinance or home equity loan, before moving forward. Shop around between lenders, as rates and fees can vary greatly from one company to the next. Make sure to compare each lender’s repayment terms and conditions carefully before moving forward.