Financial AdviceIf you’ve built up equity in your home (that’s the difference between what it’s currently worth and the amount you owe on your mortgage), then tapping into this can be a great way to pay for a renovation.
But renovating is expensive. In fact, it’s not uncommon for an entire renovation wishlist to cost $100k or more, and this means that the most common methods of financing (a home equity loan or cash-out refinance) aren’t available to recent homebuyers who haven’t yet built up equity.
Just take a look at the example below showing tappable equity on a $400k house with a 15% down payment.
And whilst home equity loans can work for long-term homeowners, those who have recently purchased may have to wait 10 years or more to have built up sufficient equity to finance their entire renovation wishlist.
And that sucks. Especially given that home improvements will typically increase the value of your home.
So what does this mean?
It means that many homeowners don’t have the equity they need to finance the full list of home improvements that they want to do. A home equity loan or HELOC won’t provide enough borrowing power to finance the full remodel costs.
Some will turn to a high-interest personal loan (sometimes marketed as a home improvement loan) or credit card to borrow the money and, unfortunately, far too many will reduce the scope of their project and renovate room by room over many years, whilst living in a never-ending construction zone.
But it doesn’t have to be this way.
Traditional home equity loans & HELOCs aren’t the best way for many homeowners to pay for their remodeling project, but alternative financing options do exist.
The problem is just that most homeowners don’t know what these are and that they could increase their borrowing power by an average of 11x.
In this guide, we’re going to help you to understand the best way for you to finance your home renovation wishlist, look at the pros and cons of using equity, and introduce you to an alternative that could allow you to borrow the most money at the lowest monthly payment … even if you have not built up sufficient equity to tap into with a traditional home equity loan or line of credit.
Specifically, you’ll learn:
Using Equity To Finance Home Improvements
Using equity to finance a home renovation project can be a smart move. But you need to understand how it works to be able to figure out your best financing option.
The bigger the difference between the amount you owe on your mortgage and the value of your home, the more equity you’ve got. And as you continue to make monthly payments, your mortgage balance decreases and your equity increases.
But your home’s value can go down, as well as up.
Property prices change regularly, and when the market is performing well and prices are on the rise, your equity will increase. But when the market is down, this can decrease the value of your home and reduce your equity. In very rare circumstances, you could even end up with negative equity, which is where you owe more on your mortgage than your house is worth.
Before rushing into making a decision on how to finance your remodel using the equity in your home, you need to consider your options and understand the pros and cons of each of these.
After all, choosing the wrong one can be a costly mistake or can massively limit your borrowing power.
So let’s start by looking at the different options that you’ve got for tapping into your home’s equity:
- Home equity loan
- Home equity line of credit (HELOC)
- Cash-out refinance
Here, we’re going to be primarily focusing on home equity loans and lines of credit, but you can learn more about refinancing in our ‘3 Reasons Why You Shouldn’t Use a Cash-Out Refinance for Renovations’ guide.
Let’s dive a little deeper into the differences between these and take a look at the pros and cons of each, before introducing you to an alternative method of financing your renovation: RenoFi Loans.
What You Need To Know About Using A Home Equity Loan For A Remodel
A home equity loan (or second mortgage) lets you borrow a lump sum amount of money against the equity in your home on a fixed interest rate and with fixed monthly payments over a fixed term of between five and 20 years, much like your first mortgage except with a shorter term.
How much you can borrow depends on your home’s market value and mortgage balance (as well as your credit score, your income and other factors), but this will usually be between 80% and 90% of what it’s currently worth minus your existing mortgage.
As an example, if your home is worth $500k and your current mortgage balance is $375k, a home equity loan could let you borrow up to $75k. (90% multiplied by $500k, minus $375k)
These are secured loans that use your home as collateral, meaning that you could lose this in the event that you are unable to make payments.
Technically, you can use the lump sum of money that you get from a home equity loan for anything, but it is typically used for home improvement projects, paying for college, medical expenses, debt consolidation, business or wedding expenses.
Home improvement projects are the most common purpose, though, with the US Census Bureau’s Housing Survey confirming that approximately 50% of home equity loans are used in this way.
Home Equity Loan Pros & Cons
So how do the pros and cons of a home equity loan stack up?
- Fixed monthly payments
- Fixed interest rates
- Lower interest rates than personal loans or credit cards
- Closing costs and fees are lower than with a refinance
- Interest may be tax-deductible if used for a major home improvement (consult your tax advisor).
- Borrowing power is limited by available equity (typically up to 90% of your home’s current value minus your outstanding mortgage). Homeowners who are renovating don’t get credit for the increasing value of their home.
- Funds being disbursed up front means you start paying interest on the full loan amount even if you may not need the funds for a few months.
Despite having many benefits, the most important thing to consider about a home equity loan is that your borrowing power will be limited unless you’ve owned your home for many years and have built up a lot of equity.
What You Need To Know About Using A Home Equity Line of Credit (HELOC) For A Remodel
A home equity line of credit (also known as a HELOC) is a revolving line of credit that’s borrowed using your home’s equity as collateral. You can use this like a credit card, taking out how much you want (up to your limit) when you want. Just like home equity loans, HELOCs are secured and act as a second mortgage.
You’re being given access to a pool of cash that you can dip into and use as and when you need it. And just like a credit card, as you pay it back, it’s available again to draw.
You have a set length of time (usually 5 to 10 years) when you can draw on your line of credit. This is known as the draw period, and during this, and payments that you make are only for the interest on the loan. After the draw period ends, you’ll have a repayment period of a further 10 to 20 years, during which you make monthly payments that repay the loan amount and interest.
A HELOC is similar to a home equity loan in many ways, but there are two distinct differences:
- A home equity loan is paid as a lump sum, whereas a HELOC gives you a revolving line of credit. This means you only pay interest on what you’ve drawn and as you make payments and repay the line, it’s available to draw again should you need it .
- A home equity loan has a fixed interest rate, but a HELOC typically comes with a variable rate.
The money from this can be used to pay for pretty much anything, but common uses include home improvements, education costs, consolidating other debt or similar.
Again, for this guide we’ll assume that it’s being used to finance a remodeling project.
To give an example of how a home equity line of credit works, let’s return to the previous example that we used.
Your home is worth $500k and you’ve got an outstanding mortgage balance of $375k. Based on borrowing against 90% of your home’s current value, you could get a HELOC for up to $75k.
But whereas with a home equity loan you would receive the full loan amount as a lump sum, in this instance it’s available as a revolving line of credit.
That means if the project you want to undertake first costs $10k, you draw only this amount from the HELOC and thus only begin paying interest on that $10k.
HELOC Pros & Cons
So how do the pros and cons of a home equity line of credit stack up?
- Flexibility to draw as much or as little as needed
- Smaller payments during the draw period when typically only interest is paid
- Lower interest rates than personal loans or credit cards
- Pay interest only on the amount that you draw
- Interest may be tax-deductible if used for a major home improvement (consult your tax advisor).
- Borrowing power is limited by available equity (typically up to 90% of your home’s current value minus your outstanding mortgage). Homeowners who are renovating don’t get credit for the increasing value of their home.
- Variable interest rates.
- Monthly payments can fluctuate.
The Problem With Using Home Equity Loans & Lines of Credit to Pay For Renovations
The real problem with using a home equity loan or line of credit to pay for a renovation for many homeowners is that their borrowing power is limited by the equity available to tap into.
And for recent homebuyers, this often isn’t sufficient to complete their full renovation wishlist.
Just take a look at this scenario:
The Jenkins family is planning a home improvement project that will cost $250k.
They purchased their home five years ago and want to do the two-story addition and kitchen remodel they’ve been discussing since they moved in.
Their home is currently worth $500k, and they owe $350k on their mortgage. It is expected that the value of their house will be $750k after the renovation is complete.
Let’s compare how much they could borrow with a home equity loan or HELOC:
| Home Equity Loan | Home Equity Line of Credit |
|---|---|
| 90% Current Home Value | 90% Current Home Value |
| $100k | $100k |
The remodel that the Jenkins want to do is out of reach; despite a home equity loan and a HELOC letting them borrow $100k, they’re still $150k short.
This is frustrating, especially when you consider that the remodel is going to add value.
So what’s the alternative?
Introducing An Alternative: RenoFi Loans
Say hello to RenoFi Loans.
We’ll explain a little more about what these are and how they work in a moment, but for starters, let’s show how the Jenkins’ borrowing power changes when comparing a RenoFi Home Equity Loan to traditional home equity loans or lines of credit.
| Home Equity Loan | Home Equity Line of Credit | RenoFi Home Equity Loan |
|---|---|---|
| 90% Current Home Value | 90% Current Home Value | 90% After Renovation Value |
| $100k | $100k | $300k |
This is more than sufficient to finance the $250k remodel that’s on the cards.
But you’re probably left wondering how the Jenkins’ borrowing power suddenly increased by so much…
It’s because RenoFi Loans allow you to borrow based on what your home’s value will be after your renovation is complete. Essentially, you’re tapping into that increase in equity right now.
The Jenkins’ are making some big improvements to their home, and its value is going to increase. But most types of financing don’t acknowledge that.
A RenoFi Loan is a new type of home renovation loan that combines the best bits of a construction loan with the simplicity of a home equity loan, whilst letting you borrow at the lowest possible interest rate and avoid the need to refinance.
Here’s what you need to know:
| RenoFi Home Equity Loan | RenoFi Home Equity Line of Credit |
|---|---|
| Ability to borrow up to 90% of the after renovation value | Ability to borrow up to 90% of the after renovation value |
| Loan amounts from $20k to $500k* | Loan amounts from $20k to $500k* |
| Same low fixed rates as traditional home equity loans | Same low variable rates as traditional HELOCs |
| Term up to 20 years | 10 year draw period, followed by 20 year amortization |
| *Varies by location |
Try the RenoFi Loan Calculator for yourself to see how much you could borrow… we’re pretty confident that it’ll be significantly higher than with other traditional equity based financing options.
How do I know if a RenoFi loan is right for my project?
The RenoFi team is standing by to help you better understand how RenoFi Loans work and the projects they are best suited for. Have a question - Chat, Email, Call now...
RenoFi CEO & Co-Founder, Justin Goldman comments on the problems faced by homeowners, stating that:
“Today, the two most popular financial products used to finance home renovations - a cash-out refinance or a home equity loan - aren’t even really designed for renovations at all.
“While they can be a good option for long-term homeowners (having lived in their home for 10+ years), they aren’t the right type of loan for recent homebuyers who haven’t yet built up equity.
“Because when equity is your only leverage, it can take years to build up enough equity to achieve your entire renovation wishlist.”
A RenoFi Loan makes it easier for you to borrow against your home’s future equity and complete your renovation wishlist straight away.
Home Equity Loans & Lines of Credit vs A Cash-Out Refinance
The other alternative to home equity loans or lines of credit for using equity to pay for a remodel is to use a cash-out refinance.
But many homeowners don’t want to refinance, as this will mean losing any great rate that they’re currently locked into.
You’ll also find that you have limited borrowing power when refinancing, in the same way as we saw above.
| Home Equity Loan | Home Equity Line of Credit | Cash-Out Refinance | RenoFi Home Equity Loan |
|---|---|---|---|
| 90% Current Home Value | 90% Current Home Value | 80% Current Home Value | 90% After Renovation Value |
| $100k | $100k | $50k | $300k |
See how the RenoFi Loan still comes out as the best way to borrow to finance your renovation if you’ve only got limited equity and have a wishlist of projects you’re itching to get going on?
Home equity loans, lines of credit and a cash-out refinance are only an option if you’ve got the equity available to tap into.
If you don’t, your borrowing power is seriously limited and you’ll either have to wait or reduce the scope of your renovation.
Neither, in our eyes, should have to happen.
Other Alternatives To Pay For Home Improvements
Using equity isn’t the only way to pay for home improvements, though, and drawing a comparison between this and other types of financing is important to make sure that you truly understand all of your options.
You can learn more about how all of these stack up in our guide on how to pay for home renovations, but let’s quickly break these down.
These other alternatives are:
- Construction loans
- Unsecured personal loans or credit cards
- Cash
Construction Loans
Construction loans get used to pay for renovations because they let you borrow based on your home’s after renovation value (therefore increasing your borrowing power in the same way as a RenoFi Loan) and for the simple fact that that many homeowners don’t know that other options exist that work in this way.
But a construction loan may not be right for your remodel for three reasons:
You’ll have to refinance, meaning you may end up on a higher interest rate.
Because you are required to refinance, you’ll have to pay closing costs on your first mortgage, which are significantly higher than closing costs on a home equity loan.
The process involves more work than alternatives, and many contractors hate them.
This translates to extra tasks like working with your contractor to create a draw schedule, organizing - and waiting on - inspection visits, the involvement of project supervisors, and the frequent communication with your lender requiring detailed plans and information throughout the construction process.
If you don’t have to go through these extra steps, why would you? They add extra time, cost and hassle to the process; things that no one wants.
Unsecured Personal Loans
Many ‘home improvement loans’ are really just high-interest unsecured personal loans that really aren’t best-suited to paying for renovations.
And here’s why that’s the case:
You’ll pay higher interest rates than the alternatives. To give an example, you’ll usually end up paying an interest rate of somewhere between 8% and 15% on a personal loan.
A RenoFi Loan, like all Home Equity Loans and HELOCS have rates today as low as 4% to 5%.
Over the years, that’s thousands and thousands of dollars more in interest. Just think how that money could be better spent.
These loans have a shorter payback period, meaning higher monthly payments.
Your borrowing power will be limited, as most people will only be able to borrow between $25k and $35k. Although some banks advertise “up to 100k,” it’s rare you’ll actually be able to borrow that much.
The interest on these loans isn’t tax-deductible.
Cash
If you can afford to do so, cash is the cheapest way to finance home improvements, as there’s no interest to be paid at all.
But the reality is that most of us don’t have that sort of money available without borrowing from retirement accounts, draining emergency savings, or borrowing from friends and family.
When cash is sourced from these places, it’s usually only because the homeowner believes there’s no alternatives available. But there usually is, they just don’t know about them.
Many homeowners often put off renovations for two years, five years, or even a decade, because they think they need to save up cash to finance their remodel project.
Or, they wait until they are about to move out to renovate, meaning they don’t have any time in their home to actually enjoy their remodel.
Especially during a time when interest rates are at a record-low, it probably makes sense for you to borrow using a home renovation loan and keep money in your emergency savings or retirement account.
Here’s how the different options that are available to you stack up:
| Renovation Home Equity Loan | Single-Close Construction To Permanent Loan (CTP) | Fannie Mae HomeStyle Loan | FHA 203k (Full) | Two-Close Construction To Permanent Loan (CTP) | |
|---|---|---|---|---|---|
| Is this a mortgage? | Yes | Yes | Yes | Yes | Yes |
| 1st or 2nd mortgage? | 2nd | 1st | 1st | 1st | 1st |
| Require refinance of existing mortgage? | No | Yes | Yes | Yes | Yes |
| Typical Interest Rate | Market | Above Market | Above Market | Above Market | Above Market |
| Loan Limit (Renovation Cost + Mortgage) | $500,000 | Jumbos allowed | Conforming only | Conforming only | Jumbos allowed |
| Loan Term (max) | 20 years | 30 years | 30 years | 30 years | 30 years |
| Credit Score Required | 660+ | 700+ | 620+ | 580+ | 580+ |
| Loan to Value | Up to 95% | Up to 95% | Up to 95% | Up to 96.5% | Up to 80% |
| Can be used for building new home? | No | Yes | No | No | Yes |
| Restrictions on type of improvements? | No | No | No | Yes | No |
Always do your homework and ensure you’re choosing the right option based on your own individual circumstances.
After all, mistakes can be costly or reduce your borrowing power.
For more information on RenoFi loans and how we can help finance your renovation in the smartest way possible whenever you’re ready, contact us today!
Home Equity Loan & HELOC FAQs
Home equity loans and lines of credit can be confusing, we get it.
To help you out, here are answers to some of the most commonly asked questions about these two renovation financing options.
What is a home equity loan?
What is a home equity line of credit (HELOC)?
Should you use a home equity loan to remodel?
Does a HELOC make sense for renovations?
How much money can you borrow with a home equity loan?
What type of loan is best for home improvements?
What if I don't have enough equity? How can you finance a home remodel without equity?
Is a home equity loan the same as a home improvement loan?
No, a home equity loan lets you tap into your home’s equity to borrow a lump sum that’s often used to pay for home improvements.
But they can also be used for other things, and common uses include covering education or medical costs.
These are a specific type of loan; a financial product that’s been designed to allow homeowners to borrow against the equity that they have built up in their homes.
A home improvement loan, on the other hand, can refer to anything. It could be any type of loan that is advertised to homeowners who want to borrow to finance a remodeling project, so it’s really important that you do your research to understand what that ‘home improvement loan’ that you’ve been offered really is.
What many don't realize is that these are often just high-interest personal loans that are marketed under the name of ‘home improvement loans,’ rather than being a specialist financial product.
Other times, the term ‘home improvement loan’ is used to refer to what’s known as a home renovation loan, a loan that lets you borrow based on your home’s after renovation value.
What are the disadvantages of a home equity loan?
The main disadvantage of taking out home equity loans for home improvement projects is that your borrowing power is limited by the amount of tappable equity that you have available.
If you’re a recent homeowner who has not built enough equity, an alternative type of home equity loan such as a RenoFi Loan could help you to borrow enough to undertake your full renovation wishlist.
Are there closing costs on a home equity loan?
Yes. Closing costs are highly variable, but are typically between $500 and $1,000. The closing costs on home equity lines of credit may be lower.
Common closing costs include:
- Application fees
- Loan origination and underwriting fees
- Appraisal fees
- Title search and escrow fees
- Credit report fees
Whilst these closing costs are typically lower than on a first mortgage, these can still amount to a noticeable sum of money on larger loans.
Do I have enough equity for a home equity loan or HELOC to finance a remodel?
Calculating whether or not a home equity loan could finance your remodel is simple and straightforward.
- Determine how much $ you need to borrow to cover the cost of your remodel.
- Multiply your home’s current value by 90%. (The maximum you can borrow against with a home equity loan is 90% of your home’s value.)
- Deduct your outstanding mortgage balance from this figure.
This will give you an estimate as to how much you could get from a home equity loan or HELOC.
Is this enough to cover the cost of your renovation?
If it’s not (which for many homeowners will be the case), consider a RenoFi Loan that lets you borrow based on your home’s after renovation value and significantly increase your borrowing power.
Which is better to finance a renovation, a fixed rate or a variable rate?
If you plan on paying off the loan over many years, the peace of mind of locking in the rate and knowing your exact payment means that a fixed rate home equity loan is likely the right choice. If you’re not sure what the total cost will be, or are going to be completing your remodel in phases and want to draw on the money as and when you need it, a variable rate home equity loan or HELOC might be a better choice.
That said, if you have only recently bought your house and do not have sufficient equity to pay for the renovation work you want to carry out, neither of these will be the best option.
Check out RenoFi Loans to see how you could borrow against your home’s future equity (based on your home increasing in value after a remodel) today.
Is the interest on home equity loans and lines of credit (HELOC) tax-deductible?
Maybe you’ve heard that, in some cases, you can deduct the interest paid on home equity loans or lines of credit on your tax return?
Typically, the interest on these loans is tax-deductible when:
- Your loan is secured against your home.
- This is used to carry out substantial improvements that add value, prolongs its useful life, or adapt it for a new use.
- The loan amount doesn’t go above $750k for a married couple or $375k for a single borrower.
For most homeowners tapping into their home’s equity to finance a renovation, they will be able to deduct this on their tax return. RenoFi Loans are also tax deductible. Please always check with your accountant.
What alternatives exist to home equity loans and HELOCs to pay for a remodel?
How do I know if a RenoFi loan is right for my project?
The RenoFi team is standing by to help you better understand how RenoFi Loans work and the projects they are best suited for. Have a question - Chat, Email, Call now...
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(This information is designed to provide general information regarding the subject matter covered. It is not intended to serve as tax, legal, or other financial advice related to individual situations. Because each individual’s tax, legal, and financial situation is different, you should seek advice based on your particular circumstances from your own accountant, attorney, and/or other advisor regarding your specific situation.)
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