Have you ever watched HGTV and wondered how the homeowners are paying for their remodel project or new home? The before and after photos are outstanding and inspiring, but how the homeowner will be paying for these projects is rarely brought up during the hour-long show.
Home improvement projects are on the minds of many new homeowners across the country, along with the price tag of these updates. The average cost of remodeling a home in the U.S. ranges from $16,886 – $64,086, depending on what you want to get done.
Whether you are just applying a fresh coat of paint or overhauling your whole house, home improvements can quickly get pricey. Once you have a budget in mind, there are many options for financing your home improvement project. Picking the right one is easily as important as picking the project itself.
Comparing Home Improvement Loan Options
There are three popular options for homeowners considering a loan for their renovation or home improvement project:
Home Equity Loan
A home equity loan is a lump sum loan that leverages the money you’ve already paid towards your house as a guarantee to the lender that you’ll repay the loan.
Home Equity Line of Credit
Commonly referred to as a HELOC loan, this option often has similar interest rate options as a home equity loan, but acts as a revolving line of credit, rather than a one-time installment.
Home Improvement Personal Loan
Unlike the first two options, a home improvement personal loan is an unsecured loan, and is not backed by your home or the money already paid towards it.
How to Calculate Your Home’s Equity
Before pursuing any of these options, you need to calculate your current home equity. Home equity is the difference between how much your home is worth and the outstanding balance of your mortgage and any other debts secured by your home.
Let’s say you buy a house for $400,000 with a down payment of $40,000 (10% of the total), and take a mortgage out for the remaining balance due, $360,000. Your home equity when you move in is equal to your down payment, $40,000.
If you paid off $20,000 of principal on your mortgage in the years that followed, but your home value didn’t change, your home equity would then be $60,000. If your home value went up to $430,000 while you were making those payments, your new home equity value would be $90,000—which is the difference between your improved home value and what you still owe the lender.
What is a Home Equity Loan?
A home equity loan is one time, lump sum loan, secured with the equity in your home. According to the Federal Trade Commission, homeowners can borrow up to 85% of their equity for a loan. Since home equity loans are secured by an asset (your house), these loans typically offer a lower APR over unsecured loans, even if you don’t have stellar credit.
Your APR will be fixed and predictable over time when building a budget. You’re even able to deduct the interest payments on the loan from your taxes in many cases. Borrowers can qualify for larger loan amounts and a longer time period than a personal loan can offer. All of this is because the lender or bank has a safety net if the borrower fails to pay. They can foreclose on your house and sell it to recover any unpaid funds.
Should I Use a Home Equity Loan?
Home equity loans can be a strong fit for borrowers who have a lot of equity in their home and need to make major and expensive improvements. Using a home equity loan on a renovation or update to your home in a way that will increase its value can be a win-win situation. They are a better fit for projects that have a total budget already set since a home equity loan is a one-time lump sum for the borrower.
Not all homeowners have significant equity in their home. This is more common for new homeowners who just haven’t invested as much in payments yet or borrowers whose home has declined in price. Home equity loans do also come with closing costs and fees similar to those of your primary mortgage.
When selecting a home equity loan it is extremely important to be sure the repayment plan is in your budget. Not making payments could result in foreclosure and the loss of your home.
What is a Home Equity Line of Credit (HELOC)?
A HELOC loan gives borrowers a line of credit to draw funds from over a longer period of time, rather than receiving a fixed lump sum all at once. As long as you stay under the borrowing limit decided on by your home equity, you can continue to draw funds, like a credit card. Like a home equity loan, interest is tax-deductible with HELOC’s. Like a home equity loan, homeowners can borrow up to 85% of their equity for a HELOC loan
One common use for a HELOC loan outside of the home improvement space is for university tuition payments. Medical bills over time are also a common use for a HELOC loan, as the borrower can draw from the line of credit continuously over time.
The other major difference between a HELOC loan and a home equity loan is the APR rate. While a home equity loan features a fixed APR, HELOC’s have variable APR. Because the interest rate isn’t locked in when starting the loan, it could rise and be trickier to budget for over time. You can also make interest-only payments during the draw period, which is the timeline when you are drawing funds from the line of credit (on average about 10 years). However, once the draw period ends you could see much higher payments due if you only make interest payments in that time.
Should I Use a Home Equity Line of Credit?
Like home equity loans, a HELOC loan is a strong option for larger projects that require more capital investment. You will also need enough home equity to borrow against, so HELOC’s might not be a strong fit for new homeowners or those who have seen their home’s price decline significantly.
Most banks won’t offer HELOC’s on rental properties, so if you are looking to make updates to an investment property you rent for additional income, a HELOC loan might not even be an option.
A HELOC loan is a strong fit for homeowners who want to continue to draw from a reserve of cash over time. For example, a total home remodel that has a long timeline with a number of payment points would benefit from a HELOC loan, rather than a single lump sum payment from a home equity loan. Unlike a home equity loan, a HELOC loan could mean adjusting loan payments over time, and if you pay back only interest during the initial draw period you could see a significant rise in payments.
As with a home equity loan, making these payments is extremely important. While the rates are lower because it is a secured loan, failing to make payments could result in foreclosure and the loss of your home.
What is a Home Improvement Loan
Unlike a HELOC or home equity loan, a home improvement personal loan is an unsecured loan. You don’t have to worry about not having enough home equity to borrow against, however, this means the lender takes on additional risk when making these loans. As such, personal loan rates tend to be higher than those for home equity loans. The rate will also be based on your creditworthiness. Earnest offers home improvement personal loans starting at 5.49%. Payments are fixed, so they are can be scheduled into a budget with no surprises month to month.
Personal loans can be used for a number of reasons beyond home improvements, including but not limited to: vacation/honeymoon, moving/relocation, security deposit, engagement/wedding, home improvement, new job expenses, and career development. Home improvement personal loans are often repaid over a shorter period than a home equity loan or HELOC loan, often three to five years.
Should I Use a Home Improvement Loan?
If your project has a shorter timeline or borrowing amount, a home improvement loan is generally a better way to go. Personal loans are generally not for loan amounts that would take over seven years to pay off. Maybe you don’t have the cash on hand for a new coat of paint for your home, which can range between $1,700 and $,3700. Personal loans are also faster to secure, taking only a couple days for approval, while home equity loans or HELOC’s can take an average of 30 days. If you have a leaky roof that needs to be fixed quickly to prevent further damage to the home price, a home improvement loan would be the faster option to get the funds for repairs.