There are many benefits to renovating your home. A good renovation can significantly enhance the value of your property, for instance, but beyond boosting the value, it also enhances the functionality and aesthetic appeal, making it a nicer place to live. And unless you’re immediately planning to sell, this might be even more important.
One popular method of funding your home renovation project is by leveraging your home equity, but is using home equity for renovations a smart financial move? Let’s look at what using home equity for renovations might look like. What are the pros and cons, how might it impact your property value, and what do you need to know to be an informed homeowner?
Home Equity: What Is It?
Home equity is the difference between the current market value of your home and the outstanding balance of your mortgage. Essentially, it’s the portion of your home that you own debt-free. For example, if your home is worth $400,000 and you’ve paid $100,000 toward the principal, your home equity is that $100,000.
Home equity isn’t just an encouraging number to see climb higher year over year. It can be leveraged as a valuable financial resource, particularly when considering major renovations or improvements.
You can go to your lending institution of choice, like a bank or credit union, and take out either a home equity loan (a lump sum) or a HELOC (home equity line of credit) to borrow from the equity you have in your home. It’s a loan, but because you’re leveraging the value of something tangible that you own, you can often get better rates.
Using Home Equity for Renovations: What Are the Pros?
There are many benefits of making home improvements and a variety of pros to using home equity for renovations:
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Boosts property value: One of the primary benefits of renovating your home is that you increase your property’s value. Strategic improvements, like modernizing the kitchen, updating bathrooms, installing a new roof, or adding a deck, can significantly enhance the appeal and marketability of your home. These renovations can ultimately have a high return on investment (ROI), potentially recouping much of the cost when you decide to sell.
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Tax benefits: In many states, the interest paid on a home equity loan or HELOC is tax-deductible, provided the funds are used for home improvements. This can result in substantial savings, reducing the cost of borrowing. Talk to a tax professional to see if there are any applicable tax advantages.
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Lower interest rates: Because you are securing a loan with your property, the lending institution has significantly lower risk, meaning that they can offer you a better deal. Home equity loans and HELOCs often come with lower interest rates compared to other forms of credit like personal loans of credit cards. If you’re planning on doing tens or hundreds of thousands of dollars in work, this can seriously affect your total spending in the long term.
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Flexible financing: As mentioned previously, home equity can be accessed through various financial methods, usually a lump-sum home equity loan or a HELOC. This flexibility lets homeowners choose the financing method that best suits their renovation plans and financial situation.
Using Home Equity for Renovations: What Are the Risks?
When making large financial decisions, it’s important to consider the entire picture. You’ve seen there are many upsides to using home equity to renovate your home—so what are the drawbacks?
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Increased debt load: Taking out a HELOC or home equity loan increases your overall debt load. This can affect your financial stability and limit your liquidity or future borrowing capacity. Before using home equity for renovations, take time to carefully consider your ability to manage additional debt.
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Risk of foreclosure: This is the biggest potential risk of using home equity for collateral on a loan. If you fail to make the required payments, you risk losing your property to foreclosure. This significant risk makes it all the more important to ensure that you have a stable, reliable income before taking on additional debt.
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Fluctuating interest rates: While home equity loans typically have fixed interest rates, some lenders might offer variable rates. HELOCs in particular often come with variable rates—which means that your monthly payments could increase if interest rates rise as they’ve done over the past couple of years. This could potentially strain your budget by making monthly payments larger than you planned for. Understanding the terms of your loan and preparing for possible rate fluctuations is vital.
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Real estate market volatility: Markets can be unpredictable. If property values decline, the amount of equity in your home may decrease, which could leave you with a higher loan balance than the current value of your home. This scenario, called being “underwater” on a mortgage, can make it challenging to refinance or sell your property.
What Homeowners Should Consider
If you’re thinking about using home equity for renovations, there are some things to consider before you apply.
What Will the ROI Be?Simply put—unless that bathroom vanity is really bugging you, you should make sure that the value you’re getting out of the project is worth it. Not all home improvements offer the same ROI. Prioritize renovations that add the most value to your property or improve life in your home.
How Stable Are Your Finances?Before you tap into your home equity, assess your situation. Ensure you have a steady income and a manageable level of existing debt. Try to give yourself a cushion to absorb any unexpected expenses.
Do You Understand the Terms and Conditions?Don’t be so excited to get a new in-ground pool that you rush through the loan process. Take time to work with your lending institution to ensure you understand everything about your home equity loan or HELOC. Pay attention to interest rates, closing costs, repayment schedules, and any potential fees or penalties.
How Does This Impact the Long-Term Plan?Homeownership is a marathon, not a sprint. Home renovations should align with your long-term goals for the property and for your life. If you intend to stay in your home for decades, you might want to prioritize improvements that can enhance your quality of life and comfort. However, if you can see yourself selling in the near future, focus on renovations that maximize ROI.
At the end of the day, renovating your home can be a great thing, both for your home’s value and for your quality of life, and leveraging your home equity is a great way to finance renovations. However, there may be risks, and you should only walk this path if you’re confident you can afford it.
If you want help using home equity for renovations, talk to a trusted lending institution like Capital Credit Union. We’ve been helping families like yours in northeast Wisconsin since 1934, and we want to help you best use your assets to improve your life and your home. We can get you started today.